Weekly Review: Municipal Bond CEFs - Confidently The Benchmark Is Reaching New Highs

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

The iShares National AMT-Free Muni Bond ETF (MUB) reported another positive week after an increase of $0.47 on a weekly basis. The main benchmark continues with its strong performance and managed to break important resistance levels which we found around $109.80 per share. Over the past week, the market participants changed their focus to safer assets such as municipal bonds dictated by the shaky performance of the stock market and unsatisfactory economic data.

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.

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

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, several funds from the sector announced their regular dividends:

  • Dreyfus Municipal Bond Infrastructure Fund (DMB) $0.0530 per share.
  • Pioneer Municipal High Income Advantage Trust (MAV) $0.0425 per share.
  • Pioneer Municipal High Income Trust (MHI) $0.0525 per share.
  • Delaware Investments National Municipal Income Fund (VFL) $0.0500 per share.
  • Delaware Investments Minnesota Municipal Income Fund II (VMM) $0.0375 per share.
  • DWS Municipal Income Trust (KTF) $0.0425 per share.
  • DWS Strategic Municipal Income Trust (KSM) $0.0475 per share.

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

Our review is starting with the Z-score indicator. It is an appropriate indicator to see how many times the discount/premium deviates from its mean for a specific period. My purpose here is to find statistically undervalued funds in the sector. On a weekly basis, we notice another slight increase in the Z-scores of the funds which seems pretty reasonable if we take into consideration that fact that all of the funds increased their net asset values.

As you see, the best that we can get is the statistical parameter which is negative and to combine it with a discount in order to review the fund as a potential "Long" candidate. Based on this approach, I see the Nuveen Arizona Premium Income Municipal Fund (NAZ) as an opportunity for those of you who want to include a focused on Arizona municipal bond CEF to their portfolios.

Once again, Pioneer Municipal High Income Advantage Trust (MAV) is the one with the lowest Z-score. On a weekly basis, its price reported an increase of 0.76% and its net asset value went up by 0.61%. The slight decrease of the discount pushed up the Z-score but we can say that it still remains the only one outlier which could be found based on the statistical indicator Z-score. I remind you that the whole pressure for the price came after a dividend cut in February.

Source: CEFConnect.com

2. Highest Z-Score

Source: CEFConnect.com

Тhe significant increase in the prices of the funds led to many Z-score which give us an opportunity to review the funds as a potential "Sell"candidates. Keep in mind that in such a strong upward trend for the sector, I avoid "naked" sell positions in funds which are still traded at a high discount even when their Z-score is relatively high.

Last week, I shared with you how surprised am I to find MFS California Municipal Fund (CCA) traded at such a high Z-score. For those of you who wanted to enter into a pair trade opportunity, I recommended to use BlackRock MuniYield California Insured Fund (MCA) as a long position. On a weekly basis, the pair traded generates 0.46% profit, but I still see a lot of potential.

Source: CEFConnect.com

Currently, the prices of the funds are deviating from their mean for 400 days period. They are traded near to their three standard deviations. The current yield of CCA is only 3.74% while MCA offers a significantly higher yield of 4.65%. The funds use quite similar effective leverage of 42%.

Source: Author's software

The Pioneer Municipal High Income Trust (MHI) was one of the best performers of the past week. The reported increase in its price is 3.04% and only 0.73% increase in the net asset value. Currently, the Z-score of MHI is one of the highest ones and I see it as an opportunity to form a pair trade. A very good option here is to use the Delaware Investments National Municipal Income Fund (VFL). A strong correlation between their net asset value and deviations between their prices.

Chart Data by YCharts

Talking about this pair trade, I want to mention the risk of dividend cut of MHI which is another strong reason for us. It offers a current yield of 5.31% and VFL offers 4.82% but the latest earning of MHI was not enough high to cover the distribution which may reflect on the dividend pretty soon.

Source: CEFdata.com

Source: Author's software

3. Biggest Discount

Source: CEFConnect.com

The sample provides us CEFs with attractive discounts of more than 12%, and I would suggest combining the spread between the price and net asset value with a relatively low Z-score. 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.

The Nuveen Pennsylvania Investment Quality Municipal Fund (NQP) is one of the interesting funds which caught my eye. Maybe a little bit surprising but the management team decided to increase the dividend of the fund from $0.0470 to $0.0505 per share from the month of March. Still based on the discount the fund seems undervalued compared to its peers. The current yield of NQP is 4.64% and 98.3% of its assets are from issuers located in Pennsylvania.

Source: Fund Sponsor Website

Source: Cefdata.com

4. Highest Premium

Source: CEFConnect.com

In the above table are the funds which are trading above their net asset values. Theoretically, the participants should be reviewed as potential "Sell" candidates, but we know the willingness of the market participants to pay more for the PIMCO funds. Except for their representatives, I continue to follow the performance of the Invesco Municipal Income Opportunities Trust (OIA). This fund sometimes goes really crazy. If we see again price trading above $8.00 per share I will definitely review it.

Chart Data by YCharts

The average discount/premium of the sector is -6.20%. Last time, the average spread between the prices and net asset values of the funds was -6.37%. 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 with the highest return on net asset value for the past five years. The average return for the sector is 5.45%. From the above participants and their parameters, only the Dreyfus Municipal Bond Infrastructure Fund (DMB) and the Eaton Vance Municipal Income Trust (EVN) caught my eye with their discounts.

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 4.57%, and the average yield on net asset value is 4.31%.

The Invesco Pennsylvania Value Municipal Income Trust (VPV) is leading the chart with its current yield of 5.67%. А worrying fact here is the earnings coverage ratio of the fund which is far below the needed 100%. The latest earnings is only 86.21% of the current dividend. In other words, we see a potential risk of a dividend cut.

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 10, 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 short position in CCA 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.