The Market Vectors CEF Municipal Income ETF seeks to replicate as closely as possible,before fees and expenses, the price and yield performance of the S-Network Municipal Bond Closed-End Fund Index. The index is intended to track the overall performance of the U.S. listed closed-end funds that invest in U.S. dollar denominated tax-exempt bonds.
The three year old fund, XMPT, (inception July 12, 2011) tracks,as mentioned, an underlying index called The S-Network Municipal Bond Closed-End Fund Index. I hadn't heard of the S-Network before so I did a little research:
The S-Networks Municipal Closed end Fund Index is a Municipal Fund Index designed to serve as a benchmark for closed-end funds in the U.S. that are principally engaged in asset management processes designed to produce federally-tax exempt annual yield.
The index, with a ticker symbol of CEFMX, uses what is termed:
[A] modified total assets methodology designed to assure accurate investment exposure across the various business segments that together comprise the federally-tax exempt annual yield sector of the closed-end fund market.
It is divided into four segments of the municipal bond Closed End Fund Market: 1) Leverage, 2) Unleveraged, 3) High yield and, 4) High Yield Leveraged. What is interesting is there are presently 130 Closed End Funds included in the fund universe that can be selected for the index but at present the index is using only 85 of them. There are certain inclusion criteria for the index including capitalization ($100M) and average daily turnover ($.5M per day)along with certain other criteria. The index is rebalanced quarterly and reconstituted semi-annually.
Returning to the fund itself, it uses the same 85 funds of the index in its structure. Because of the nature of being an ETF Fund of Funds,the issue of expenses looms quite large. The acquired funds of the FOF have expenses of 1.25%, with a gross expense ratio of 2.28%. These expenses are said to be "acquired" because they are not borne by the fund and not technically passed through to the investor from the original fund. Without confusing everyone, there is a waiver and reimbursement of -.63% for a net expense ration of 1.65%. The advisor (Van Eck Associates, Corporation) has contractually capped the fees to .40% which is similar to their other ETFs (and the ones we have previously analyzed). This cap is set to expire on September 1 of this year:
This is set to continue after this date until such time that the Board of Trustees of the Advisors decides to act to discontinue all or a portion of such expense limitation.
My analysis is they should continue this at the same expense structure/ratio for the conceivable future.
One concern I do have is the AUM and the diversification of this FOF. Let's address these issues before we discuss performance and whether it is a good investment with the so called "Discount Advantage" strategy.
The fund presently has only $34.22M net assets as of July 31, 2014. The big question I have is, where is everyone? Without addressing the performance, (which I feel is attractive), there are a few reasons for lack of investor interest. For one, let's understand the top 15 holdings.
For information purposes here are the top fifteen funds in the ETF, their underlying symbols, and their weightings:
- Nuveen Municipal Value Fund Inc (NYSE:NUV) 4.09%
- Blackrock Municipal Target Term Trust (NYSE:BTT) 3.74%
- Nuveen Municipal Opportunity Fund Inc (NIO) 3.65%
- Nuveen Premium Income Municipal Fund 2 Inc (NYSE:NPM) 2.88%
- Nuveen AMT-Free Municipal Income Fund of Benef Interest (NYSE:NEA) 2.83%
- Nuveen Premium Income Municipal Fund Inc (NYSE:NPI) 2.55%
- Invesco Municipal Opportunity Trust of Benef Interest (NYSE:VMO) 2.46%
- BlackRock MuniYield Quality Fund III Inc (NYSE:MYI) 2.43%
- Nuveen Performance Plus Municipal Fund Inc (NYSE:NPP) 2.35%
- Nuveen Quality Income Municipal Fund Inc (NQU) 2.28%
- Eaton Vance Municipal Bond Fund of Benef Interest (NYSEMKT:EIM) 2.27%
- Invesco Trust for Investment Grade Municipals of Benef Interest (NYSE:VGM) 2.06%
- Invesco Municipal Trust of Benef Interest (NYSE:VKQ) 2.02%
- Invesco Trusts Invesco Quality Municipal Income Trust of Benef Interest (NYSE:IQI) 1.90%
- Nuveen Dividend Advantage Municipal Fund III of Benef Interest (NYSEMKT:NZF) 1.86%
These top 15 represent approximately 40% of the holdings with the remaining 60 funds equal to approximately 60%. At this point, I am sure the readers are thinking "this is evenly balanced." That is both good and bad in the municipal market and hence, one of the reasons for lack of participants/investors here. Eight of the top fifteen are Nuveen funds or 53%. That isn't necessarily bad but there is a lack of diversification of fund managers. This is a fact. There are only so many municipal fund managers and only so much municipal debt in the marketplace. Most of the issues in the municipal marketplace are in general, small. As such, diversification is tough to achieve. If I am a fund manager and need to sell an issue due to my team's analysis on a pending downgrade there are only so many other funds who will acquire the position. Yes, the banks or remaining investment banks may hold a position but after the new Volckner rule(s), many will not take the risk on their balance sheet and hold the position indefinitely. As such, when one fund goes down, others simply follow. As such, the funds are so similar with underlying core holdings that there is true diversification. In this sense it is tough to achieve any difference between the various fund returns. Yes, there are short term, long term, leverage, unleverage, high yield CEFs, etc but not a plethora of issues. Is this necessarily a bad thing readers may ask? No, for the simple reason that institutions stay away from this type of vehicle. They may be able to achieve outsized returns on a pull back of the sector but there is no advantage to placing large endowment (or small for that matter) in the fund. This will assure retail investors of not getting "whipsawed" by hedge funds playing the major market moves. As I mentioned in my previous analysis, it will also prevent this fund from growing to scale, i.e. $100M+. Again, is that necessarily a bad thing? No, as long as VanEck keeps the fees low and can assure that the return is linked to the underlying index. Let's discuss the returns and the strategy of "The Discount Advantage."
Tax Free 5.68%
XMPT's SEC yield is presently a tax free 5.68% for a taxable equivalent of 9.41% in the 39.6% bracket and a YTD (July 31) return is 12.01% (at the share price). Its one year after tax hold is 10.40%. A portion of the income, of course, is subject to AMT within this ETF. Dividends are paid monthly and capital gains yearly. Share volume by the way, is abysmal with average daily volume (3m) at 8,151. 52-week low is $22.52 and high is $26.17, with a closing price of $25.87, +.11 on August 28.
"The Discount Advantage"
In terms of the strategy "The Discount Advantage," according to Van Eck, is a term derived from the index itself:
The index assigns greater weightings to CEF's trading at a discount, which should enhance the yield and the opportunity for capital appreciation.
As such, there is an opportunity when the fund matches the index and the underlying CEF's trade near their NAV. My analysis would indicate, once an individual CEF exceeds its NAV, at that point the index is rebalanced and that specific CEF is replaced with a new fund (from the fund universe of the index). This occurs when the fund is reconstituted. In an interest rate hike, there will be downward share price pressure but it will only be exasperated on the leveraged issues in the FOF. The overall portfolio will actually provide an adequate cushion for investors without the resources to purchase pure municipals in a separate account or in an individual portfolio.
I should note that it would take a tremendous amount of time to break down the individual holdings of the FOF and its CEF's. As such, the diversification of an ETF CEF is not necessarily a bad thing for retail investors who desire a tax free diversified (fund manager) return and a definite way to reduce single fund risk. In terms of overall diversification of positions this will only allow as much diversification as the Municipal market holds, but for an attractive tax free return with only a small institutional holding and a low expense ratio, I recommend XMPT.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.