Seeking Alpha

Weekly Review: Municipal Bond CEFs - Dividend Cut For Most Of PIMCO Funds

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Includes: BAF, BBF, BFZ, BTA, BYM, CEV, CMU, CXE, DMB, DMF, DSM, EIM, ENX, EOT, EVM, EVY, IIM, IQI, LEO, MMD, MUB, MUI, OIA, PCK, PCQ, PMF, PML, PMX, PNF, PNI, PYN, PZC, TLT, VCF, VCV, VGM, VKI, VKQ, VMO, VPV
by: Arbitrage Trader
Arbitrage Trader
Arbitrage, debt, bonds, short-term horizon
Summary

Impressive performance from the benchmark in the first days of the new year.

The most important event from the last week was the dividend cut in most of the PIMCO closed-end funds.

We continue to follow the most important yields and municipal/Treasury spread ratio.

Most of the funds from the sector are still trading at positive Z-scores, and we do not see a statistical edge to include some of them in our portfolio.

Introduction

Over the past year, the municipal bonds showed a very strong performance, and they managed to increase their prices significantly. The end of the year is a fact, and it is very interesting to see what will be the performance of the sector in 2020. Of course, the policy of the central bank of the United States will play a big role. The municipal bonds are fixed-income instruments with a relatively long duration, and the changes in the interest rate are crucial for their results. However, the first days of the new year were positive, and most of the closed-end funds increased their prices. The biggest event from the last week was the dividend cut of several PIMCO funds. For some of them, we informed our readers that investing in them at so high price is very dangerous, and the risk is not justified.

The Benchmark

Positive first days of the year for the benchmark of the municipal bonds. The iShares National Muni Bond ETF (MUB) rose by $0.44 and finished Friday's session at $114.42 per share.

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 (NASDAQ:TLT). 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 News

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

Many of the closed-end funds from the sector announced dividends:

  • Dreyfus Municipal Bond Infrastructure Fund (DMB) $0.0530 per share.
  • Eaton Vance California Municipal Income Trust (CEV) $0.0446 per share.
  • Eaton Vance Municipal Bond Fund (EIM) $0.0429 per share.
  • Eaton Vance New York Municipal Bond Fund (ENX) $0.0390 per share.
  • Eaton Vance National Municipal Opportunities Trust (EOT) $0.0717 per share.
  • Eaton Vance California Municipal Bond Fund (EVM) $0.0366 per share.
  • Eaton Vance New York Municipal Income Trust (EVY) $0.0433 per share.
  • BlackRock Municipal Income Investment QualityTrust (BAF) $0.0515 per share.
  • BlackRock Municipal Income Investment Trust (BBF) $0.0505 per share.
  • BlackRock Long-Term Municipal Advantage Trust (BTA) $0.0505 per share.
  • BlackRock Municipal Income Quality Trust (BYM) $0.0480 per share.
  • BlackRock Muni Intermediate Duration Fund (MUI) $0.0445 per share.
  • MFS High Yield Municipal Trust (CMU) $0.0185 per share.
  • MFS High Income Municipal Trust (CXE) $0.0210 per share.
  • Invesco Value Municipal Income Trust (IIM) $0.0588 per share.
  • Invesco Quality Municipal Income Trust (IQI) $0.0487 per share.
  • Invesco Municipal Income Opportunities Trust (OIA) $0.0316 per share.
  • Invesco California Value Municipal Income Trust (VCV) $0.0430 per share.
  • Invesco Trust for Investment Grade Municipals (VGM) $0.0516 per share.
  • Invesco Advantage Municipal Income Trust II (VKI) $0.0450 per share.
  • Invesco Municipal Trust (VKQ) $0.0489 per share.
  • Invesco Municipal Opportunity Trust (VMO) $0.0500 per share.
  • Invesco Pennsylvania Value Municipal Income Trust (VPV) $0.0483 per share.
  • MainStay DefinedTerm Municipal Opportunities Fund (MMD) $0.0850 per share.
  • Dreyfus Municipal Income (DMF) $0.0350 per share.
  • Dreyfus Strategic Municipal Bond Fund (DSM) $0.0300 per share.
  • Dreyfus Strategic Municipals (LEO) $0.0350 per share.
  • PIMCO Municipal Income Fund (PMF) $0.0540 per share. Decreased by ($0.0057)
  • PIMCO California Municipal Income Fund (PCQ) $0.0650 per share. Decreased by ($0.0120)
  • PIMCO New York Municipal Income Fund (PNF) $0.0420 per share. Decreased by ($0.0110)
  • PIMCO Municipal Income Fund II (PML) $0.0590 per share. Decreased by ($0.0060)
  • PIMCO California Municipal Income Fund II (PCK) $0.0320 per share. Decreased by ($0.0030)
  • PIMCO Municipal Income Fund III (PMX) $0.0460 per share. Decreased by ($0.0047)
  • PIMCO California Municipal Income Fund III (PZC) $0.0380 per share. Decreased by ($0.0039)
  • PIMCO New York Municipal Income Fund II (PNI) $0.0401 per share.
  • PIMCO New York Municipal Income Fund III (PYN) $0.0355 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

Definitely, a positive week for the closed-end funds which invest in municipal bonds. All of the funds from the sector reported increases in their net asset values. No doubt the biggest news of the week is related to the PIMCO representatives and the changes in their dividends. It is not a big surprise to see that PIMCO New York Municipal Income Fund (NYSE:PNF) is the worst price performer of the past week as its dividend cut of 20.80% was the highest one among the PIMCO CEFs. On the other side of the coin, Delaware Investments Colorado Municipal Income Fund (NYSEMKT:VCF) showed very solid performance and left in a green territory by 2.21%.

To figure out which of the funds from the sector are statistically undervalued, we use the Z-score indicator. We use it on 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 do not provide us with a statistical edge.

BlackRock Municipal Income Investment Trust (NYSE:BBF) is one of the CEFs that are traded at a negative Z-score and offers a very competitive current yield of 4.48%. The main parts of the investments are with ratings of "AA" and "A". Definitely a great quality here. The assets in the portfolio from issuers located in California are 11.00%, and those from Illinois are 12.14%.

Source: Fund Sponsor Website

The number of holdings in the portfolio is 191, and "Transportation" and "Health" are the sectors with the biggest weights. Another important characteristic of the portfolio is that its effective duration is 11.47 years, and its yield to worst is 3.84%.

Source: Fund Sponsor Website

2. Highest Z-Score

Source: CEFConnect.com

The highest value of the Z-score may be an indication that the closed-end funds are overpriced, and it is time to close your long positions. We should admit that the interest rate decreases over the past year changed the fundamental environment on the market, and we do find a logic behind the significant increase in the prices of the municipal bond closed-end funds. However, if the Z-score of some CEF is above 2.00 points, you may want to think about the alternative opportunity in some other similar CEF with lower Z-score. This will increase your chances of a potential capital gain.

The biggest winner of the past week was VCF. From me, this fund is overpriced compared to its peers, and you can easily notice this fact on the chart below. The Z-score of VCF is indicating that this CEF is statistically expensive. On the other hand, the fund is traded at a premium, and its current yield is not so attractive at this price.

Source: CEFData

The average 1-year Z-score in the sector is 0.73 points. Last time, the average Z-score of the municipal sector was 0.88 points.

Source: CEFConnect.com

3. Biggest Discount

Source: CEFConnect.com

Still many of the funds are traded at a discount of more than 10.00%. 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.

Source: Fund Sponsor Website

If you want to extend your investments in California, then the BlackRock California Municipal Income Trust (NYSE:BFZ) may catch your attention. It has one of the highest discounts in the area. The current yield of the fund is 3.32%, and the yield on net asset value is 2.94%. The credit quality of BFZ is more than impressive, as 70.99% of its investments are rated as "AA".

Source: Fund Sponsor Website

4. Highest Premium

Source: CEFConnect.com

In my articles, many times, I spoke about PIMCO California Municipal Income Fund (NYSE:PCQ) and the rest of the overpriced PIMCO municipal bond CEFs. I share with you my thoughts about the risk which is hidden behind the high premium of PCQ and its potential dividend cut. Well, finally, this "sinking boat" (as I used to call it) began to sink. The management team decreased its dividend by 15.60%, and I do expect to see a decrease in its premium very soon. The current yield at these prices will be 3.95%, which is significantly lower than the 4.68% which was offered before the dividend change.

The average discount/premium of the sector is -4.40%. Last time, the average spread between the prices and the net asset values of the funds was -4.10%.

Source: CEFConnect.com

5. Highest 5-year Annualized Return On NAV

Source: CEFConnect.com

These are the top ten closed-end funds that outperformed their peers by return on net asset value over the past five years. The average return on net asset value for the past five years for the sector is 4.70%.

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 the price is 4.06%, and the average yield on net asset value is 3.89%.

My recommendation here is to also check the earnings/coverage ratio and the UNII per share balances of the funds which offer higher yields. I am saying that because, if the earnings are not high enough to cover the dividend, it is possible to see a decrease in the distribution, which is going to affect the yield of the funds, and it is very likely to see a decrease in the price. The recent dividend change of PIMCO CEFs is a very good example of what I am talking about.

7. Lowest Effective Leverage %

Source: CEFConnect.com

The average effective leverage of the sector is 33.1%. Logically, most of the funds with lower effective leverage have lower distribution rates compared to the rest of the closed-end funds. Three funds from the sector have effective leverage equal to zero.

Source: CEFConnect.com

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

Conclusion

Compared to the previous years, the discounts of the closed-end funds holding such products have significantly widened, but we remain cautious when we select our long positions due to the high Z-scores in the sector. However, there are several interesting trades that you can review if you use the discount as a metric.

Note: This article was originally published on January 05, 2020, 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 PCQ 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.