EOT: A High Yield Muni Bond Fund For Risk Taking Investors

|
About: Eaton Vance National Municipal Opportunities Trust (EOT)
by: Dilantha De Silva
Summary

EOT yields 4.5% at the current market price.

The monthly-paying nature of the fund is one of the most attractive features of EOT.

The fund invests in non-investment grade securities as well.

Slow and steady economic growth in the U.S. should support EOT performance.

The case for municipal bonds

Municipal bonds outperformed many other fixed income categories in 2018, and the positive momentum is expected to continue in 2019 as well. In a report, Charles Schwab Corporation concluded that the outlook for municipal bonds remains positive for 2019 as well, but the asset manager suggests a cautious approach considering the interest rate environment and geopolitical risks.

(Source - Charles Schwab)

Higher-rated bond issues are preferred by Charles Schwab, not only considering the lower credit risk, but also the lower yield spread between high rated issues and low rated issues.

As the U.S. economy matures, the possibility of an economic recession within the next 5 years is seemingly high than the possibility of higher than expected economic growth in the next 5 years, which might prompt the FED to hold interest rates stable. This summarizes the need to move up the capital structure by reducing the exposure to equities which would perform the worst if an economic crisis hits the country.

During economic crises, muni bonds have easily outperformed equity market performance historically. Even though the U.S. economy is still firing on all cylinders, diversifying into an asset class that has historically outperformed equities at times of crises is a reasonable step to make considering the expected slowdown in economic activities in 2019 and beyond. A further escalation in the trade war between the U.S. and China will certainly aggravate the situation.

(Source - Advisor Perspectives)

In addition to providing better returns when the underlying economic condition is unattractive, municipal bonds have historically provided very attractive tax-adjusted returns.

(Source - Advisor Perspectives)

Municipal bonds are a good choice when the U.S. economy is nearing its maturity, which is where we are at present.

The patient stance of the Fed, as confirmed by the Fed Chair, Jerome Powell, supported the bond markets in Q1 2019. The expectations of an economic slowdown in the country helped the decline of bond yields in Q1. According to the Investment Company Institute (ICI), inflows into municipal bonds totaled $23.9 billion in the first quarter, which is a remarkable improvement from the Q4 2018 figures as municipal bonds saw outflows in Q4 2018.

Eaton Vance National Municipal Opportunities Trust

Established in 2009, Eaton Vance National Municipal Opportunities Trust (EOT) seeks to provide attractive income returns to its investors on a monthly basis. The fund is actively managed to identify and exploit investment opportunities present in the municipal bond sector. Since its inception, the EOT has provided an attractive market return to investors, but performed negatively in 2018.

(Source - Eaton Vance)

The monthly income distribution is one of the distinct characteristics of the fund. At present, EOT pays a monthly dividend of $0.0859 per share, which comes to a dividend yield of just over 4.6% at the current market price.

(Source - Morningstar)

The monthly paying structure of the fund is particularly attractive to income investors as this brings a steady stream of periodic income, which is one of the primary reasons behind the increasing popularity of monthly paying funds among retirees as this brings about a consistency to income-oriented investors.

The expense ratio is 0.96%, which is significantly higher than many ETFs. However, EOT is actively managed, which naturally results in higher fees.

(Source - Eaton Vance)

Even though the growth of passive funds has disrupted the wealth management industry, actively managed bond funds offer unique advantages to investors. Passive bond funds often track investment grade bonds but there are a number of non-investment grade bonds that offer attractive risk-adjusted returns to investors. On the other hand, an active fund manager is permitted to take on more or less duration as seen necessary to generate alpha, which is an important consideration in delivering better than market returns to investors. Considering these benefits to investors and the historical performance of the fund, the expense ratio of 0.96% can be justified.

Portfolio composition

The portfolio of EOT is inclined toward longer-dated bonds. Approximately 95% of fund assets are invested in bonds with a maturity of over 10 years, making the fund overweight on longer-dated bonds.

(Source - Morningstar)

Longer-dated bonds are helping EOT receive higher coupons for their investments. However, if interest rates rise further, holding longer-dated bonds in the portfolio will prove to be a disadvantage as these bonds are very sensitive to interest rates.

78% of the bonds in the portfolio offer yields between 4-8%, which comes on the back of holding longer-dated bonds. In fact, the average coupon is 5.25% as of March 31.

(Source - Morningstar)

Over 40% of the bonds in EOT's portfolio has a Fitch rating of BBB or below, which depicts a high level of investment in non-investment grade or near non-investment grade bonds.

(Source - Morningstar)

The top 10 holdings of the portfolio account for close to 22% of the total investment portfolio. The investment portfolio is spread across 159 constituents. Considering the long-dated nature of portfolio constituents and the investments in non-investment grade bonds, spreading the portfolio across a number of issues makes sense as it helps mitigate issuer risk to some extent. None of the individual holdings exceed 3% of the portfolio value.

Top 10 holdings

(Source - Eaton Vance)

There are 3 Zero Coupon Bonds in the top 10 portfolio constituents, and the Adventist Health SystemSunbelt Obligated Group bond is scheduled to mature in 2019. The remaining 6 bonds are long-dated ones and have high coupon rates, which should support income distributions in the long-run.

The fund is overweight on the transportation sector but has exposure to many other sectors through its portfolio of investments.

(Source - CEF Connect)

From a geographical footprint, the fund has the highest exposure to Texas. However, the fund has meaningful exposure to many other States as well.

(Source - CEF Connect)

Future outlook

Since the inception of the fund, EOT has traded below the NAV for many years. This was the case in 2018 as well, but the fund is now trading at a premium to the NAV.

(Source - CEF Connect)

The attractive income distributed by the fund is one of the reasons for EOT to trade at a premium to its NAV, in my opinion. The consensus estimate is for interest rates to remain stable throughout 2019, and this was confirmed by the Fed Chair, Jerome Powell in March. The recent dot plot reveals that there are no rate hikes planned for 2019, at least as of today.

The dot plot as of December 2018

The dot plot as of March 2019

(Source - Bloomberg)

Stable interest rates will help bond prices recover, but at the same time, investors should not eliminate the possibility of further interest rate hikes as the U.S. economy is continuing to fire on all cylinders. In the first quarter of 2019, the U.S. economy outperformed analyst estimates and grew at an annualized rate of 3.2%. The reported rate of growth easily outperformed the growth expectations of economists polled by the Dow Jones, which was reported at 2.5%. The significant outperformance of expectations came in as a result of higher than expected decline in the trade deficit and robust growth of inventories.

Annualized GDP growth rate in the U.S.

(Source - Trading Economics)

However, the World Bank projects economic growth in the U.S. to decelerate through 2021 and settle for a more sustainable rate of growth.

(Source - World Bank)

The U.S. economy is projected to grow at a slow and steady rate for many years to come, which is a positive for the municipal bond market. Inflation remains a key consideration as an unwarranted spike in inflation could lead to further rate hikes from the Fed to keep inflation at target levels.

Conclusion

EOT yields over 4.5% at the current market price and considering the future outlook for the U.S. economy, income investors should find this muni fund attractive at the current market price. Further interest rate hikes are the biggest concern for investors, but it is unlikely that the Fed will hike rates further from the current level. EOT invests in non-investment grade bonds as well, which makes the fund suitable for risk-taking investors. EOT is not the type of income generating fund that an investor would want to invest in and forget for the rest of the life, but rather, it would be a good addition to the portfolio of an investor who focuses on income.

*If you enjoyed this article and wish to receive updates on our latest research, click "Follow" next to my name at the top of this article.

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.