Weekly Review: Municipal Bond CEFs - One More Merger In The Sector Is Completed

by: Arbitrage Trader

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.


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

Over the past week, the iShares National AMT-Free Muni Bond ETF (MUB) reported a slight decrease of $0.27 and finished the week at $109.58 per share. It is important to notice the fact that the main benchmark distributed its regular monthly dividend. For the month of March, the payout amount is $0.2467 per share. So, as a generalization, I could say that the index of the municipal bonds continues its stable performance.

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

As you know, we follow the performance of the U.S. Treasury bonds - considering them a risk-free product - with maturities greater than 20 years: the iShares 20+ Year Treasury Bond ETF (TLT). The reason for that is the strong correlation between these major indices, and the chart below proves it. Additionally, a statistical comparison is provided by our database software.

There is a fact which concerns me a little bit and probably you would like to take into consideration if you hold a long position in MUB or some of the municipal bond closed-end funds. First of all, I have to mention that municipal bonds have longer duration compared to the corporate bonds and high-yield bonds for example. Currently, the spread between TLT and MUB is very widened compared to their average spread for the last 400 days. If we see a decrease in TLT and an increase in the Treasury yields in the next weeks, I think it may reflect the municipal bonds sector, as well.

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

Source: Author's software

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

The narrowing spread and 3-month LIBOR are important for the leveraged municipal funds, and they can be highly affected by them. The 3-month LIBOR rate is a commonly used funding benchmark for the municipal bond CEFs.

Chart Data by YCharts

Source: YCharts.com, 10-2 Year Treasury Yield Spread and 3-Month LIBOR based on US Dollar

The News

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

Over the past week, the merger of Eaton Vance New Jersey Municipal Income Trust (EVJ) into Eaton Vance Municipal Income Trust (EVN) was completed at the close of the New York Stock Exchange on February 22, 2019. The exchange ratio at which common shares of EVJ were converted to common shares of EVN is 1.033252458.

Many funds from the sector announced their regular dividends. Among these were the Munis sponsored by:

  • Nuveen
    • Nuveen Municipal High Income Opportunity Fund (NMZ) $0.0030 change from the prior distribution.
    • Nuveen Intermediate Duration Quality Muni (NIQ) $0.0020 change from the prior distribution.
    • Nuveen New York Select Tax-Free Income Portfolio (NXN) -$0.0025 change from the prior distribution.
    • Nuveen Georgia Dividend Advantage Municipal Funds 2 (NKG) $0.0025 change from the prior distribution.
    • Nuveen Minnesota Muni Income (NMS) -$0.0020 change from the prior distribution.
    • Nuveen North Carolina Premium Income Municipal Fund (NNC) $0.0030 change from the prior distribution.
    • Nuveen Pennsylvania Investment Quality Municipal Fund (NQP) $0.0035 change from the prior distribution.
  • BlackRock
    • BlackRock Municipal Bond Trust (BBK) -$0.0090 change from the prior distribution.
    • BlackRock Munienhanced Fund (MEN) -$0.0040 change from the prior distribution.
    • BlackRock MuniHoldings Investment Quality Fund (MFL) -$0.0040 change from the prior distribution.
    • BlackRock MuniHoldings Quality Fund (MUS) -$0.0060 change from the prior distribution.
    • BlackRock MuniVest Fund II (MVT) -$0.0040 change from the prior distribution.
    • BlackRock MuniYield California Fund (MYC) -$0.0040 change from the prior distribution.
    • BlackRock Florida Municipal 2020 Term Trust (BFO) -$0.0060 change from the prior distribution.
    • BlackRock New York Municipal Bond Trust (BQH) $0.0020 change from the prior distribution.
  • Massachusetts Financial Services
  • Eaton Vance
    • Eaton Vance Senior Income Trust (EVF) $0.0010 change from the prior distribution.
    • Eaton Vance Floating-Rate 2022 Target Term Trust (EFL) $0.0010 change from the prior distribution.
  • Invesco
    • Invesco Advantage Municipal Income Trust II (VKI) -$0.0043 change from the prior distribution.
    • Invesco California Value Municipal Income Trust (VCV) -$0.0029 change from the prior distribution.
    • Invesco Municipal Opportunity Trust (VMO) -$0.0054 change from the prior distribution.
    • Invesco Municipal Trust (VKQ) -$0.0008 change from the prior distribution.
    • Invesco Quality Municipal Income Trust (IQI) -$0.0015 change from the prior distribution.
    • Invesco Trust For Investment Grade New York Municipals (VTN) -$0.0048 change from the prior distribution.
    • Invesco Value Municipal Income Trust (IIM) -$0.0006 change from the prior distribution.
  • Dreyfus

Weekly Charts

1. Biggest price decrease

Source: CEFConnect.com

2. Biggest price increase

Source: CEFConnect.com

Review Of Municipal Bond CEFs

1. Lowest Z-Score

Source: CEFConnect.com

The first criterion which is part of my analysis is the Z-score of the closed-end funds from the sector. It is a statistical approach which helps us to figure out how many times the discount/premium deviates from its mean for a specific period. Respectively if the Z-score is negative we can talk about a statistical edge to buy the funds. It is getting even better if we combine the statistical indicator with an attractive discount in order to review the fund as a potential "Long" candidate.

If you follow the performance of the municipal bonds and closed-end funds which invest in such kind of bonds you will not be surprised if I tell you that currently, it is difficult to find statistical edge among the funds. This fact is just a consequence of the significant increases in the prices of the closed-end funds over the last two months.

Pioneer Municipal High Income Advantage Trust (MAV) continues to lead the ranking with its Z-score of -1.40 points. The fundamental reason for the decrease in the price could be found in the recent dividend cut. The management team decided to decrease the distribution in February from $0.0525 to $0.0425 per share in an attempt to improve the earning coverage ratio of the fund.

Chart Data by YCharts

Delaware Investments National Municipal Income Fund (VFL) is taking the last position in the ranking with a Z-score of 0.10 point and a discount of 12.93%. Yes, the Z-score is not negative but it is still pretty low on a relative basis. Fundamentally, I like the fund because it has one of the lowest durations in the sector and we observe significant improvement in its UNII/Share balance.

Source: CEFdata.com

Source: CEFdata.com

2. Highest Z-Score

Source: CEFConnect.com

The main aim here is to show us which of the funds are statistically overpriced at the moment. Ideally, to find a reasonable "Sell" candidate, we would like to have a statistical edge accompanied by a premium or price pretty close to the net asset value.

PIMCO Municipal Income Fund III (PMX) is the fund with the highest Z-score in the sector. Additionally, we have a premium of 15.76%. At first glance, it looks like a potential "Short" candidate but I would like to share with you that my personal experience convinced me that selling PIMCO funds without strong fundamental or technical logic could be a painful move.

MFS California Municipal Fund (CCA) seems like a fund which should not be here at so high Z-score. I mentioned last week that you can form a pair trade with BlackRock MuniYield California Insured Fund (MCA). The correlation between their net asset values is 0.98 point but as you see on the chart below the price of CCA deviated significantly. The discount of MCA is 10.93% while the spread between the price and net asset value of CCA is only 7.11%.


Additionally, the pair trade makes sense even from a yield point of view. The current yield of CCA is only 3.63% while MCA offers a significantly higher yield of 4.76%. The funds use quite similar effective leverage of 42%.

Source: Author's software

Source: Author's software

3. Biggest Discount

Source: CEFConnect.com

Still many of the funds are traded at a discount of more than 13.00%. Very quick research will show us that most of them are state-specific. The national Munis are currently traded at a smaller discount, most probably due to their diversified portfolio.

From the above table, BlackRock MuniHoldings New Jersey Quality Fund (MUJ) is one of the interesting options. One of the highest discounts and still relatively low Z-score. The earning coverage ratio of the fund is 104.95% which is a positive indicator for the dividend and can be perceived аs margin of safety for the future distributions.

Source: Cefdata.com

A brief check of the portfolio shows that 91.27% of the investments are by issuers located in New Jersey and 35.91% of the assets are labeled as "A" rating. The current yield of MUJ is 4.77% while the yield on the net asset value is 4.13%.

Source: Fund Sponsor Website

4. Highest Premium

Source: CEFConnect.com

We have already discussed the situation around the PIMCO funds so I would not spend more time on them. It is pretty obvious the market participants are willing to pay a premium for them on a regular basis.

Invesco Municipal Income Opportunities Trust (OIA) is a fund which I follow. Its premium and Z-score are still low to enter into a sell position but if we see again so widened spread between its price and net asset value as it was at the end of August 2018 I would review it as a potential "Sell" candidate.

Chart Data by YCharts

The average discount/premium of the sector is -6.37%. Last time, the average spread between the prices and net asset values of the funds was -6.83%. Slowly and gradually the funds manage to narrow the spread between their prices and net asset value.

Source: CEFConnect.com

5. Highest 5-Year Annualized Return On NAV

Source: CEFConnect.com

The above sample shows the funds which outperformed their peers. The average return on net asset value for the past five years for the sector is 5.21%.

As you see, most of the participants are sponsored by Pacific Investment Management Company LLC, and these good results are the reason why the market participants are willing to pay more for them. All of the funds from PIMCO which are traded at discount or close their net asset values should be reviewed as potential additions to your portfolio. In our case, we have Pimco California Municipal Income Fund II (PCK) which is traded only at 3.68% premium.

6. Highest Distribution Rate:

Source: CEFConnect.com

The table shows the funds with the highest distribution rate on price. Additionally, I have included here the distribution rate based on net asset value. Most of the market participants find the second metric to be more important. The average yield on price is 4.63%, and the average yield on net asset value is 4.35%.

My recommendation here is to check also the earning coverage ratio and the UNII/Share balances of the funds which offer higher yields. I am saying it because if the earning are not enough high to cover the dividend is possible to see a decrease of the distribution which is going to affect the yield of the funds and it is very likely to see a decrease in its price.

Below on the chart, I plotted the yields of funds from the sector traded at a discount and negative Z-score.

Source: CEFConnect.com

7. Lowest Effective Leverage %

Source: CEFConnect.com

The average effective leverage of the sector is 36.3%. Logically, most of the funds with lower effective leverage have lower distribution rates compared to the rest of the closed-end funds. Seven funds from the sector have effective leverage is equal to zero.

Below you can find the chart of the funds with the lowest effective leverage and their yields on price. If you are not a big fan of the high leverage, this chart will be very helpful.

Source: CEFConnect.com


Definitely, the change of the interest rates will play a role, and we should anticipate a reflection on the Muni sector as well. Compared to the previous year, the discounts of the closed-end funds holding such products have significantly widened. 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 on March 03, 2019, 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 PCK 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.