The Nuveen Intermediate Duration Municipal Term Fund (NID) is a recently launched municipal bond closed-end fund. NID came public through an IPO at the end of 2012, when investors were clamoring for yield and before talk of the Federal Reserve tapering program began. The fund has seen a rough start, as municipal bonds have been hit by negative headlines from large borrowers like Detroit and Puerto Rico. The negative headlines have been compounded by concerns of rising interest rates putting pressure on fixed income prices. These issues have pushed NID to a wide discount, generating an attractive opportunity in this fixed income fund.
Key Investment Highlights:
- 10-Year Term Fund at a Discount to NAV: NID has a 10-year term and intends to liquidate and distribute its then-current net assets to shareholders on 3/31/2023. NID closed 2/26/2014 trading at a 9.02% discount to NAV. The discount should narrow over time, as concerns in the Muni market are addressed. If not, the prospects of the fund's liquidation will narrow the discount as the termination date approaches.
- Share Repurchase Authorization: In November 2013, the fund's board of directors/trustees authorized an open-market share repurchase program allowing for the repurchase of 4,690,000 shares. This represents approximately 10% of outstanding shares. This share repurchase program should help narrow the discount to NAV.
- Underlying Holdings Trading Below Par: As of 1/31/2014, the average price of bonds in the portfolio was 99.87. This shows, on average, investors aren't buying into bonds trading above par that will jeopardize the NAV in an attempt to generate a higher yield.
- Duration Management: The fund expects to maintain a portfolio with an intermediate duration. The duration is targeted to be between 3 and 10 years, including the effects of leverage. This target, along with active duration management, should reduce the risks associated with rising interest rates.
- Attractive Yield With Upside Potential: NID currently offers a 5.76% tax-free yield at current market prices. This equates to an 8.77% taxable equivalent yield (as calculated by CEFConnect). NID raised its distribution in February 2014. NID is earning 102.11% of its distribution and has $0.0479 in UNII, which could allow the fund to raise the distribution if these trends continue.
Key Investment Risks:
- Bond Default Risk: NID is able to invest up to 50% of its portfolio in bonds that are below investment-grade, or that are deemed by the manager to be below-investment grade quality. This increases the credit risk, particularly in light of the headlines coming out of Puerto Rico and Detroit.
- Interest Rate Risk: The economy has started to show some strength, and the Federal Reserve has started tapering its quantitative easing program. This has led to expectations that interest rates will be rising in the future. Some of this is already factored into the yield curve, but if interest rates rise faster than is expected, it will pressure fixed income investments. The fund manages this risk by using an intermediate duration mandate when investing the portfolio. Leverage-adjusted effective duration was 9.37 years, as of 1/31/2014.
Key Portfolio Metrics:
- Premium/Discount: -9.73%
- Market Distribution Rate: 5.76%
- Tax-Equivalent Yield: 8.77%
- Current Monthly Distribution: $0.057
- Average Earnings/Share: $0.0582
- Average Earnings/Distribution: 102.11%
- UNII Per Share: $0.0479
- Average Portfolio Coupon: 6.11%
- Effective Leverage: 36.17%
- % Portfolio Pre-refunded: 0.54%
- % subject to AMT: 10.36%
- Effective Duration: 6.60 years
- Leverage-Adjusted Effective Duration 9.37 years
- Average Bond Price $99.87
Using an ETF with a similar investment objective gives a good comparison to allow for evaluation of the management's performance. The Market Vectors High-Yield Municipal Index ETF (HYD) seems to offer similar investment opportunity to NID, and allows a comparison to evaluate performance. However, HYD doesn't use leverage, so the effect of leverage must also be considered when comparing the funds. As mentioned above, NID is a relatively young fund, so there isn't much history to evaluate the fund's performance. However, over the short term, NID compares favorably to HYD from a total return perspective.
Data as of 2/27/2014 Source: Morningstar
Data as of 2/27/2014 Source: Morningstar
The fund closed 2/26/2013 at a 9.02% discount to the NAV, or underlying value of the portfolio. This is below the 52-week average discount of 7.40%. The defined term of the fund should drive the discount to narrow over time. The recent expansion in the discount is likely due to concern about Puerto Rico, Detroit, and the expectation of rising interest rates. These concerns are also being watched by the fund's management team, which should allow the fund to position itself in a way that minimizes these risks.
NID has both a tiered fund-level fee for the fund itself and a tiered complex-level fee paid to the investment advisor based on daily managed assets of all Nuveen Funds. As of 11/30/2013, the complex-level fee was 0.1679%. The annual expense ratio for NID as of 1/31/2014 was 1.26%. The expense ratio is made of 0.84% in management fees, 0.08% in other expenses, and 0.34% in interest expense from leverage.
NID pays a monthly distribution of $0.057/share. This equates to an annual distribution yield of 5.76%, based on current market prices. The distribution was raised from $0.055/share for the February distribution. Based on the UNII and the level of earnings on the portfolio, the distribution is well-covered and has the potential to increase over time.
NID employs leverage through $175,000,000 of Variable Rate MuniFund Term Preferred Shares (VMTP). The VMTPs were issued in privately negotiated offerings to qualified institutional buyers. The fund is able to redeem the VMTPs, however, they must pay a premium if they choose to redeem the shares before 8/7/2014. The VMTPs must redeem the shares by 3/1/2016. As of 11/30/2013, the annualized dividend rate on the VMTPs was 1.22%. The fund can also use other forms of leverage. Current regulatory leverage is 22.22% and total effective leverage is 36.17%. The use of leverage can increase the volatility of the portfolio.
NID is fairly large for a municipal bond CEF, with $619 million in net assets. Trading volume is reasonable, with 157,000 shares traded on average. This represents $1.9 million in daily volume at current prices. This is a reasonable amount of liquidity for a CEF and should allow individual investors the ability to get their orders filled. It is always wise to use limit orders to purchase or sell shares of closed-end funds, as the bid/ask spread can be wide.
NID is managed by Nuveen Asset Management. Nuveen is a leader in municipal investing, with significant experience in mutual funds and closed-end funds.
As you would expect, the fund is almost completely invested in municipal securities, with a small allocation to swaps and other assets.
The fund offers diverse exposure to municipal securities in most states. Florida, Texas, California, and Illinois have the highest allocations. Key areas to note in light of recent news headlines include 4.39% of the portfolio invested in Puerto Rico and 4.16% invested in Michigan. Many of the investments in Puerto Rico are insured. Most of the non-insured issues have dedicated revenue sources, or are senior in the structure to improve the likelihood of repayment if Puerto Rico suffered a negative credit event. NID has a wide range of holdings in Michigan, but only a small exposure to Detroit. This quote from the recent annual report helps reduce the concern about NID's Detroit exposure.
"In NID, our holdings consisted largely of city water and sewer bonds. In addition, these bonds are supported by revenue streams generated by service fees. During this reporting period NID sold out of its position in uninsured Detroit GOs, but continued to hold insured GOs."
NID also holds Detroit-related issues that are not obligations of the city. These issues are not included in the bankruptcy filing, and include Detroit City School District bonds backed by the state of Michigan, and Wayne County Airport bonds.
NID holds bonds backed by a wide verity of sectors, with large allocations to Healthcare, Tobacco Settlement bonds, Transportation bonds, and Education bonds. The fund only has 8.1% exposure to general obligation bonds.
30.9% of the portfolio is currently invested in securities that can be identified as non-investment grade, with another 25.1% not rated by the ratings agencies. The large percentage of below-investment grade bonds shows that the portfolio is not without risk. However, the portfolio is not purely below investment-grade. As shown in the pie chart and detailed in the strategy section below, NID must invest at least half of its portfolio in investment-grade securities. Also, past municipal defaults have seen strong recoveries. Overall, the portfolio should be monitored but doesn't cause significant concern in the hands of a skilled management team.
The portfolio does have some call exposure. If interest rates stay low for a while longer, there is some risk that bonds in the portfolio will be called away. Often, bonds with call exposure offer a higher yield to compensate for the risk of being called. The portfolio was put together relatively recently, and yields haven't moved significantly. If a security is called, the management team should have similar options available to reinvest the proceeds.
NID offers a diverse portfolio, with 401 positions and only 18.66% of the fund in the top ten holdings. The fund is relatively new, but turnover has been low at around 20% annually.
NID's primary investment objective is to provide a high level of current income exempt from regular federal income tax, with a secondary objective of additional total return. The fund invests in municipal securities that are exempt from federal income taxes, and seeks to maintain an intermediate effective duration of between 3 and 10 years, including the effects of leverage. The fund invests at least 50% of managed assets in investment-grade municipal securities or securities judged by the manager to be of investment-grade quality if the bonds are unrated. The fund can invest up to 50% of managed assets in securities that are below investment-grade or judged to be of below-investment grade quality by the manager if the securities are unrated. Up to 30% of the portfolio may pay interest that is taxable under the alternative minimum tax. The fund intends to liquidate and distribute its then current net assets to investors on or before 3/31/2023.
As of November 30, 2013, the fund had $67,085,899 of unrealized losses in the portfolio. These losses, together with $4,159,891 losses taken in prior periods can be used to offset any gains realized in the portfolio. Additionally, the fund invests in federally tax-exempt securities, with only 10.36% of the portfolio's holdings subject to AMT. This should limit the federal tax impact from investing in this fund.
Recent concerns in the municipal bond market have opened up an investment opportunity in tax-exempt CEFs. NID looks like an interesting investment opportunity for individuals looking to invest based on this opportunity. Credit concerns from Puerto Rico and Detroit seem to be addressed by the fund's manager. NID is trading at a large discount, which should narrow as the municipal bond market stabilizes. The fund offers an attractive and well-covered yield with the potential to increase over time. Finally, if the discount is not addressed by the market, there are catalysts to close the discount over time, including the share repurchase program and the 2023 fund-termination date.