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Weekly Review: Municipal Bond CEFs - The Benchmark Distributed Its Dividend

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Includes: BZM, EVN, MMU, MPA, MUA, MUB, NPN, PCQ, PMF, PML, TLT, VPV
by: Arbitrage Trader
Arbitrage Trader
Arbitrage, debt, bonds, short-term horizon
Summary

The returned appetite for riskier assets was the main reason for the slight decrease in the municipal bonds sector.

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 week, the market participants did not seem interested in safer assets such as municipal bonds. The appetite for higher yields was again on focus as the volatility caused by the coronavirus was normalized.

Throughout the article, you are going to see that the period is not the best one to be aggressive and to include many of the closed-end funds from this sector to your portfolio. We are cautious because the prices are relatively high from our perspective. Also, in our weekly articles, we are trying to show you which of the closed-end funds are treated by dividend cuts.

The Benchmark

The iShares National Muni Bond ETF (MUB) fell by $0.31 and finished Friday's session at $115.49 per share. It is important to mention that the ex-dividend date of the main index was on Monday, and it distributed a monthly dividend of $0.22 per share.

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

Source: Dividend.com

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 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

Over the past week, the closed-end funds sponsored by Delaware, Invesco, PIMCO, BlackRock, Nuveen, and MFS announced their monthly distribution. In general, there is no dividend change from these funds which surprise us or can change our opinion about some of these funds.

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 investors were seeking again riskier assets for higher return and this fact had its reflection on the municipal bonds sector. Most of the closed-end funds which invest in municipal bonds reported a slight decrease in their net asset values. Regarding the prices, BlackRock MuniAssets Fund (MUA) was the best performer of the week with an increase of 4.06%. On the other hand, the price of Nuveen Pennsylvania Municipal Value Fund (NPN) fell by 6.52%.

Based on the statistical indicator Z-score we do not see many undervalued funds in the sector. Most of the Munis which are part of the above table are there because of a recent dividend decrease. As you can see, PIMCO funds are a very good example of what I am talking about.

One of the potential interesting CEFs which can be analyzed in more detail is Western Asset Managed Municipals Portfolio (MMU). From a statistical point of view, it is undervalued compared to its peers from the sector.

Source: CEFData.com

As expected, the reason behind its low Z-score is the recent decrease in its dividend. The management team of MMU decided to decrease it from $0.0505 to $0.0450 per share. However, the current yield of this CEF is 3.89% and it remains very competitive to its peers. The main part of the assets is with ratings of "AA" and "A" and most of the investments of the portfolio are from "Industrial Revenue" and "Transportation" sectors.

Source: Fund Sponsor Website

2. Highest Z-Score

Source: CEFConnect.com

We have already used the Z-score to find statistically undervalued closed-end funds from the area. In this section, we are going to see if there are statistically overpriced funds. From our perspective, the CEFs that have Z-score above 2.00 points can be labeled as overpriced. Therefore, we avoid buying such closed-end funds.

As you see, we have plenty of Munis which are traded above this border of 2.00 points and these are the funds that we are not going to buy now. The leader of the ranking is Eaton Vance Municipal Income Trust (EVN). The current yield of 4.21% is very attractive for the sector but you should keep in mind that the earnings/coverage ratio of the fund is already below 100% and it is possible to see dividend cut very soon.

Source: CEFData.com

BlackRock Maryland Municipal Bond Trust (BZM) is another closed-end fund that is often discussed in our recent articles. The fund is overpriced from a statistical point of view but is also traded at a premium which does not make sense for me because of the low current yield of only 2.73%. The upside potential of this CEF is very limited from every aspect.

The average one-year Z-score in the sector is 1.22 points. Last time, the average Z-score of the municipal sector was 1.00 points.

Source: CEFConnect.com

3. Biggest Discount

Source: CEFConnect.com

Still, many of the funds are traded at a discount of more than 9.00%. 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.

The BlackRock MuniYield Pennsylvania Quality Fund (MPA) is on the first positions after the announced dividend cut in June 2019 from $0.0530 to $0.0460 per share. For me, it was a surprise to understand that the decision of the management team because the earnings/coverage ratio of the fund was around 100% and it seemed like it does not have any issues with the distribution of the dividend.

Source: CEFData.com

A brief check of the portfolio shows that 96.97 of the investments are by issuers located in Pennsylvania and 39.04% of the assets are labeled as "A" rating. The current yield of MPA is 3.73%, while the yield on the net asset value is 3.36%. Despite the decreased dividend, MPA yield continues to be competitive for the sector.

Source: Fund Sponsor Website

4. Highest Premium

Source: CEFConnect.com

PIMCO funds continue to be the ones that are traded at the highest premium. The trust in the management team and the good past results are one of the main reasons why the market participants want to have them even at a price higher than the net asset value. My simple recommendation here is to stay away from long positions in PIMCO California Municipal Income Fund (PCQ), PIMCO Municipal Income Fund (PMF) and PIMCO Municipal Income Fund II (PML). I find them as overpriced due to their high Z-scores and premiums.

If you have a long position in BlackRock MuniAssets Fund (MUA), I see the current period as favorable to close it and to select another good buying opportunity from the sector. My personal opinion is that it is overpriced compared to its peers, and its Z-score and premium are the confirming signals.

Source: CEFData.com

The average discount/premium of the sector is -3.59%. Last time, the average spread between the prices and net asset values of the funds was -3.93%.

Source: CEFConnect.com

5. Highest 5-year Annualized Return On NAV

Source: CEFConnect.com

Above, we saw the willingness of the market participants to pay a premium for the PIMCO funds. This table could be a good explanation of that desire and why PIMCO funds are differently treated. The funds from this sponsor proved that they can outperform 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 4.69%.

6. Highest Distribution Rate:

Source: CEFConnect.com

In this section, we see which are the funds with the highest current yields. The average yield on the price for the sector is 3.90%, and the average yield on net asset value is 3.77%.

Unfortunately, most of them are overpriced based on their Z-scores. Of course, each of us wants to achieve a higher return, but you need to pay attention to the fundamental analysis and to avoid these ones which are threatened by dividend cuts. The case with Invesco Pennsylvania Value Municipal Income Trust (VPV) was a very good example. It had the highest yield in the sector, but the earnings per share were not enough high to cover the dividend, and the management team decided to decrease it from $0.0580 to $0.0483 per share.

Source: CEFAnalyzer

7. Lowest Effective Leverage %

Source: CEFConnect.com

The average effective leverage of the sector is 32.6%. 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 February 09, 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 MUA 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.