Weekly Review: Municipal Bond CEFs

| About: PIMCO Municipal (PML)

Summary

Review of where municipal closed-end funds and their benchmark ended the week.

Comparison of the yields and Municipal/Treasury spread ratio.

Recap of news related to the sector.

Comparison among the funds using several important metrics.

Introduction

Over the past few months, most of you have noticed our increased activity in closed-end funds as the inflow of volatility finally shook them up and created various arbitrage, and directional, opportunities for active traders like us.

Now that these products have grabbed our attention, we are continuously monitoring most funds by sector and will reinstate our Weekly Review, publishing a recap of the groups of interest.

The Benchmark

Source: Barchart.com - iShares National AMT-Free Muni Bond ETF

Over the past week, the price of the iShares National AMT-Free Muni Bond ETF (NYSEARCA:MUB) did not surprise us with any directional changes. On Friday, the main benchmark finished the session in green territory and with a $0.13 increase on a weekly basis.

We did not observe any significant movements of the Treasury yields. During the first week of the month, investors pivoted toward safer assets amid growing concerns about emerging market risk and trade turmoil between the U.S. and other nations. This allowed most of the fixed-income instruments to increase their prices. We consider the performance of the 10-year Treasury yield as an important player, and an eventual breakout of 3% may be a key factor for the prices of the fixed-income assets.

Source: CNBC.com, US 10-Year yields

I will compare the municipal sector to U.S. Treasury bonds - considering them the risk-free product - with maturities greater than 20 years: the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT). The chart below proves the strong correlation between these major indices. Additionally, a statistical comparison is provided by our database software:

Source: Barchart.com - iShares 20+ Year Treasury Bond ETF

Source: Author's software

Comparison Of The Yields And Municipal/Treasury Spread Ratio

Investing in municipal bonds is popular because they have the potential to offer higher yields than similar taxable bonds. If an investor wants to know whether muni bonds are cheap in comparison to taxable bonds or Treasuries, they could find out by comparing them. However, this method does have its limitations, and the investor should perform a more thorough analysis before making a decision:

Source: Bloomberg.com, Municipal and Treasury Yields

Source: Bloomberg.com, Municipal and Treasury Yields

The Municipal/Treasury spread ratio, or M/T ratio as it is more commonly known, is a comparison of the current yield of municipal bonds to U.S. Treasuries. It aims to ascertain whether or not municipal bonds are an attractive buy in comparison. Essentially, an M/T ratio north of 1 means that investors receive the tax benefit of muni bonds for free, making them even more attractive for high net worth investors with higher tax rate considerations.

Source: Bloomberg.com, Municipal and Treasury Yields

Source: Bloomberg.com, M/T Ratio 10 Years Term

The News

Source: Yahoo News, Municipal Bond Closed-End Funds News

Over the past week, several funds announced their regular dividends. All of them are with no change from the prior distribution.

Fund Distribution per share Change from the prior distribution
Pioneer Municipal High Income Trust (MHI) $0.0525 -
Pioneer Municipal High Income Advantage Trust (MAV) $0.0525 -
Dreyfus Municipal Bond Infrastructure Fund (DMB) $0.0530 -
Delaware Investments Minnesota Municipal Income Fund II (VMM) $0.0375 -
Delaware Investments National Municipal Income Fund (VFL) $0.0500 -
DWS Strategic Municipal Income Trust (KSM) $0.0500 -
DWS Municipal Income Trust (KTF) $0.0525 -

Review Of Municipal Bond CEFs

1. Lowest Z-Score

Source: CEFConnect.com

To figure out which of the funds from the sector are statistically undervalued, we use the Z-score indicator. We use it for a one-year basis to see how many times the current discount deviates from its mean for that period. For those of you who follow the performance of the sector, it should not be a surprise that most of the funds provide us with a great statistical edge.

Our undisputed leader is the Nuveen Arizona Premium Income Municipal Fund (NYSE:NAZ). On a weekly basis, the fund's Z-score is decreasing, and I think it deserves to be reviewed.

What caught my attention was the Massachusetts Health&Education Tax-Exempt Trust (NYSEMKT:MHE). Last time, it was in the first position in the sample. This week, it is not even in the ranking. Especially for this fund, the frequent shifting from a premium to a discount seems like a normal behavior.

Source: CEFConnect.com, Massachusetts Health&Education Tax-Exempt Trust

2. Highest Z-Score

Source: CEFConnect.com

On the other hand, I am sorting the table by the highest one-year Z-score, with the aim to find the most statistically overpriced CEFs from the sector. The situation remains the same as we used to see it over the past several months. When the Z-score is between 0 and 1, we do not have a statistical reason to sell any of these funds.

Last time, I reviewed the PIMCO Municipal Income Fund II (NYSE:PML) as a potential "Short" candidate or just to use it as a hedging reaction of your "Long" positions. The fund has lost part of its statistical edge due to the price decrease over the past week. Anyway, from a statistical point of view, it still seems logical to review it as a potential "Sell" candidate.

Source: Barchart.com - PIMCO Municipal Income Fund II

3. Biggest Discount

Source: CEFConnect.com

The sample provides us CEFs with attractive discounts of more than 15%. Our leader again is the Eaton Vance New Jersey Municipal Income Trust (NYSEMKT:EVJ), whose price has fallen around 0.7% below the net asset value and pushed the Z-score lower accordingly. Analyzing these municipal bond CEFs on a weekly basis is worthwhile because we should be able to notice when the time has come to include them in our portfolio. Bargain hunting is not done overnight.

4. Highest Premium

Source: CEFConnect.com

On the other hand, we see that it is getting easier to find funds traded at a premium. Once again, we see the market's willingness to pay more for "PIMCO" funds than their net asset values. My personal opinion is that if you want to short a "PIMCO" fund, you need to have a strong statistical or fundamental logic behind your trade.

Except the PIMCO Municipal Income Fund II, I do not see a statistical reason to discuss the rest of the funds. I am going to restrict myself from including some of them in my pair trade suggestion.

5. Highest 5-year Annualized Return On NAV

Source: CEFConnect.com

The above sample shows the funds with the highest return on net asset value for the past five years. The leader here, once again, is the Eaton Vance Municipal Income Trust (NYSE:EVN). This week, we find two more funds which are crossing the border of 7%. Here, we have a confirmation of our observation. Most of the participants in the above table are "PIMCO" funds, and maybe these satisfying returns are the reason why the market pays a premium for them.

6. Lowest 5-year Annualized Return On NAV

Source: CEFConnect.com

The above funds sponsored by Nuveen Fund Advisors offer the lowest returns on NAV for the past 5 years. I would not exclude them as potential "Buys" before making a brief comparison between these Nuveen CEFs and Nuveen's top payers. The credit structure can tell us the story.

As you probably remember, one of the principles of Economics says: "High levels of risk are typically associated with high potential returns." In our case, we are talking about municipal bond CEFs, but we can find a difference in their credit quality. I can conclude that it all depends on how risk-averse you are.

Source: CEFConnect.com, Nuveen Connecticut Premium Income Municipal Fund

Source: CEFConnect.com, Nuveen Dividend Advantage Municipal Income Fund

7. Highest Distribution Rate:

Source: CEFConnect.com

If you are wondering which of the funds has the highest distribution rate on price, the above sample can help you to find the answer. Additionally, I have plotted here the distribution rate based on the net asset value. Most of the market participants find the second metric to be the more important one.

8. Lowest Effective Leverage %

Source: CEFConnect.com

From a leverage perspective, we have six closed-end funds whose effective leverage is equal to zero. Do not underestimate the effect of the leverage, and be sure it is included in your analysis.

Conclusion

The price of the iShares National AMT-Free Muni Bond ETF finished the week in the green territory. Over the past two months, we saw significant recovery, but we still can feel the pressure from the future expectations of rising Treasury yields. Definitely, the change in interest rates will play a role, and we should anticipate a reflection in the Muni sector, as well. Compared to the previous year, the discounts of the closed-end funds holding such products have widened significantly. While I find this to be fundamentally justified, I always expect some buying impulse to give us at least a mean-reversion trade in these products.

Note: This article was originally published for our subscribers on 6/10/2018, and some figures and charts may not be entirely up to date.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EVJ, NAZ over 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.