Possible Additions To The 7% CEF Portfolio; Municipal Bond CEFs That Offer Effective Yields Of 7-8%

| About: Nuveen Municipal (NMZ)

Summary

Five year comparisons of 5 municipal bond funds that can be purchased like stocks.

Several CEFs covered offer effective returns of 7% or more.

Several ETFs offer effective returns of 4% without using leverage.

Some comments on my last article written on the $100,000 7% CEF portfolio suggested I look at several CEFs that I didn't cover. After taking a short look at several of them, I decided to dig deeper and researched the following funds; Nuveen Municipal High Income Opportunity Fund (NYSE:NMZ), Dreyfus Strategic Municipal Bond Fund, Inc. (NYSE:DSM) and Invesco Trust for Investment Grade Municipals (NYSE:VGM). After putting these into TD Ameritrade's compare funds table, several ETFs came up to research as well; VanEck Vectors AMT-Free Long Muni ETF (NYSEARCA:MLN), and PowerShares National AMT-Free MuniBd ETF (NYSEARCA:PZA).

The resulting table is shown below.

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Source: TD Ameritrade Web Site

Starting with DSM, the balance of the article looks at the 5 year history of each of the funds listed above.

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Source: Interactive Brokers Web Site

This 5 year graph shows that DSM sold for $7.75 at the beginning of the period and reached a high of $9.75 before descending back down to the $7.00 region. It sold in a narrow range for 2 years and just recently began to ascend to the $9.00 region again. DSM is currently paying $.0415 monthly for a 5.5% yield which is .5 cent lower than at the beginning of the 5 year period. It is worthwhile noting that if one has a federal tax rate of 25%, the effective yield in a taxable account is 7.4%

If this fund could be purchased at anything below $8.00 per share, it represents a buy. This CEF appears to be selling too high to purchase at the current price since the NAV as of 8/3/16 is listed at $8.93 and the selling price is $9.03, indicating DSM is selling at a slight premium. Typically this CEF sells at a considerable discount to NAV. The chart between NAV and selling price is shown below.

Source: CEFConnect Web Site

One also needs to know that DSM uses about 30% leverage which would adversely affect NAV and the market price of the fund if interest rates were to rise.

The next CEF to consider is NMZ and the 5 year graph is shown below.

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Source: Interactive Brokers Web Site

NMZ starts the 5 year period with a market price of $11.25 per share and currently sells at $15.00 per share. It offers a monthly dividend that amounts to a 6% annual payout. The dividend has grown slightly over the 5 year period from $0.073 per share to $0.076 per share. NMZ is selling at a 6% premium to NAV which is somewhat higher than normal as one can see in the graph below.

Source: CEFConnect Web Site

NMZ is offering the investor who has a federal tax rate of 25% an effective yield of 8% which does make this fund attractive even despite the premium. If one is considering NMZ as an investment in one's taxable portfolio, it makes sense to dollar average the purchases over a period of 12 - 18 months. NMZ also uses 30% leverage, so rising interest rates would savage the NAV and selling price of the fund. Therefore it would be wise to avoid this CEF if one is convinced interest rates are about to climb.

The next 5 year graph belongs to VGM and is displayed below.

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Source: Interactive Brokers Web Site

VGM started the period at $13.50 per share paying $0.088 monthly. It currently sells for $14.50 per share and pays $0.073 monthly for a yield of 5.2%. Assuming a federal tax rate of 25%, the effective tax rate in a taxable account is currently at 7%.

This CEF like the 2 above has moved upward from $13.00 to $14.50 per share over the past 9 months reducing the yield about .5%. Unlike the other 2 CEFs VGM sells at a 3% discount to NAV which is lower than usual. You can see the graph illustrating the relationship between NAV and selling price below.

Source: CEFConnect Web Site

VGM uses 10% more leverage than the 2 CEFs listed above with an effective leverage of 40%. Therefore this fund will take more damage when and if interest rates increase which makes this CEF riskier than the 2 above. For this reason it's prudent to only buy this fund when the discount to NAV is relatively large. For that reason VGM does not appear to be a buy at current levels.

The next 2 funds are ETFs rather than CEFs; starting with MLN the 5 year graph is below.

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Source: Interactive Brokers Web Site

MLN started the 5 year period at $18.00 per share and currently sells for nearly $21.00 per share. This ETF pays monthly but the payments are different every month. The current payments run about $0.05 per share and total just over $0.60 per share annually. The yield is around 3% so that the effective dividend rate for someone in the 25% federal tax bracket is 4%. This ETF does not use leverage, but it has most of its investments in long term bonds; over 70% of the bonds have maturities going out 20 years or longer. So while MLN does not expose the investor to the risk of leverage, it still exposes one to the risk of loss if interest rates move upward.

MLN is a fund for the risk-averse long term investor who is in a high tax bracket. Anyone who is considering taking a position in this ETF should do it over an 18 - 24 month period of time to level off the buying price.

The final ETF to consider is PZA and the 5 year market price graph is displayed below.

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Source: Interactive Brokers Web Site

PZA started the period at $24.00 per share and currently sells for $26.25 per share. This ETF also has a varying dividend each month. At the beginning of the 5 year period, the payments were averaging about $0.09 per month, but they have declined considerably and are now running at about $0.07 per month so that the current yield is 3%. Here again if one is in the 25% federal tax bracket, the effective return is around 4%. While this ETF does not use leverage, over 70% of the bonds have maturities beyond 20 years. So PZA is exposed to the same interest rate risk as MLN and one should exercise the same caution if one plans to invest in this fund.

For those of you who have followed the series of articles on building a 7% CEF portfolio referred to above, several of these CEFs could be used as a good substitute or addition to a taxable portfolio. NMZ and/or DSM could be used as substitutes or additions for any of the tax advantaged funds listed in the portfolio. Since all of these funds are at or near their annual highs, one would be wise to spread out purchases in these CEFs over a 12 - 24 month span to hopefully lower one's buy-in cost.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.