NBB: A More Attractive Taxable Muni Fund
Summary
- CEF discounts held in on Tuesday despite sharp moves lower in risky assets.
- We recently recommended BBN, however, it is unfortunately no longer trading at bargain prices and another taxable muni fund - NBB is more attractive.
- We like NBB for its attractive discount valuation, decent historic returns, controlled price drawdowns and high distribution coverage.
- This idea was discussed in more depth with members of my private investing community, Systematic Income. Get started today »
Risky assets tumbled again on Tuesday, despite bold moves by the Fed and other central banks. The CEF market, however, remained firm in discount terms, we suspect, because income investors continued to snap up bargains. We recently recommended the Blackrock Taxable Municipal Bond Trust (BBN) in another article, however, the sharp rally in BBN makes it no longer a bargain. Another fund in the sector, however, has remained relatively cheap - the Nuveen Taxable Municipal Income Fund (NYSE:NBB). We like the fund for its discount valuation, decent historic returns, controlled price drawdowns and high distribution coverage.
But First, A Bird's Eye View Of The CEF Market
In this section, we take a look at how the overall market has performed since the drawdown began. The price behavior across CEFs has on aggregate been as expected: as risky assets have dropped and volatility risen, CEF discounts have widened and NAVs have fallen. While this is true in aggregate, there are two puzzles that stand out to us.
The first puzzle has to do with how discounts have performed so far across sectors. The highest-volatility sectors have seen the least amount of discount widening - not something we would have expected. This is likely because these sectors have dropped the most in price terms and have attracted more investor demand while those sectors that held in well were most likely sold to raise cash.
Source: ADS Analytics LLC, Tiingo
This view agrees with the chart below which shows that sectors with the biggest price drops have seen their discounts outperform.
Source: ADS Analytics LLC, Tiingo
Let's see how the average CEF sector discount has moved through this sell-off. Mostly the picture below makes sense - as equities sold off from reduced risk appetite, CEF discounts have widened. One day where the two did not move in sync was on Tuesday when the average discount tightened despite a sharp drop in stocks. The explanation for this puzzle, we suspect, is similar to the first - discounts held in on the day because CEF investors have begun to put cash to work and acquire funds which in aggregate has supported the market.
Source: ADS Analytics LLC, Tiingo
The average sector discount has recovered about half of its top-to-bottom drop of 6%. In order to benchmark the widening, let's see how this dynamic compares against the December-2018 sell-off. In that episode the average sector discount moved about 4% from 7% to 11% whereas in this episode the discount has moved 5% from about 1% to 6% and has now retraced to about 3%. Top to bottom the recent discount widening is comparable to the December-2018 episode although it has been much sharper.
Source: ADS Analytics LLC, Tiingo
What can we make of the current picture? Is the current discount widening "fair" and does it present a buying opportunity?
Firstly, an average discount widening of about 3% especially from a much higher base level than we saw in 2018 is certainly disappointing. The sharpness of the reversal did not give investors a lot of time for bottom fishing. We would not be surprised if discounts head wider again, particularly if risk appetite remains poor and news flow challenging, however, we need to factor in one important difference from December-2018 - the level of yields.
During the previous drawdown episode, we saw not only a much higher level of longer-term rates but also a rise in short-term rates. Over the previous couple of weeks, on the other hand, we saw a big drop across the entire curve of about 0.60%. This means two things for CEFs: first, the cost of leverage has dropped significantly leading to a rise of very roughly 0.10% - 0.30% in net investment income yield for higher-yielding CEFs which rely on short-term leverage. And secondly, it leaves CEFs even more of "the only game in town" kind of investment which still provides a decent yield. All in all, this means that while we would love to see the discount head wider, the current level may be the best we're going to get. And it will be good enough for many income investors who see no other opportunities than to go into CEFs in the current market environment.
Nuveen Taxable Municipal Income Fund
The Nuveen Taxable Municipal Income Fund is a $972m total asset fund with a 1% total fee on net assets. Less than 10% of the portfolio is rated non-investment grade. The effective duration of the fund is quite long at nearly 22 years. Top region exposures are California, New York and Illinois which together make up nearly half of the portfolio.
It may seem odd to recommend a long-duration fund given the rock-bottom level of interest rates. However, in our view long duration assets should always be part of investor portfolios regardless of valuation. This is because long duration assets can serve as ballast during risk-off periods, such as the one we are witnessing now. It can also throw off decent amount of income without taking excessive credit risk. Finally, it can help to protect investor principal.
Another reason to allocate marginally to longer duration assets is that the longer end of the yield curve has been steepening which provides improved rolldown returns as asset duration moves lower with time and their yields "slide" down the curve.
Source: ADS Analytics LLC, FRED
The fund's overall valuation is the most attractive in the sector. The fund's absolute discount is the widest in the sector and its 1-year and 5-year z-scores are the lowest. The discount percentile since 2000 is in the bottom third.
Source: Systematic Income CEF Investor Tool
The differential between the discount and the sector average discount is on the low side.
Source: Systematic Income CEF Investor Tool
The fund's distribution coverage is high at 108% and has been rising steadily.
Source: Systematic Income CEF Investor Tool
The UNII figure has been rising as well after bottoming late last year.
Source: Systematic Income CEF Investor Tool
Historic NAV returns are mixed but respectable.
Source: Systematic Income CEF Investor Tool
The fund's historic price drawdowns have been fairly contained. Part of this has to do with the fund's partial hedging of its duration exposure through interest rate swaps. Given the current low level of nominal and real rates this presents a good risk-reward in our view.
Source: Systematic Income CEF Investor Tool
Conclusion
The firm behavior in CEF discounts suggests that income investors have begun to snap up bargains, supporting the broader market. Although the total discount drawdown to date has not been as large as we would like, it is similar in magnitude to what we saw in December-2018. This suggests that unless the market turns sharply lower and risk appetite drops further this may be as good as it gets for the CEF investors. We currently like NBB - a long-duration taxable muni fund given its attractive discount valuation, decent historic returns, controlled price drawdowns and high distribution coverage.
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This article was written by
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Analyst’s Disclosure: I am/we are long NBB. 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.
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