NBB: I Just Bought This Fund For Its Relative Value

Summary

• NBB has a lower premium than other taxable muni CEFs.
• Taxable munis offer higher income, on a tax-adjusted basis, than tax-exempt munis for most tax filers right now.
• The majority of the underlying bonds in the fund are rated A or better.

Main Thesis

The purpose of this article is to evaluate the Nuveen Taxable Municipal Income Fund (NYSE:NBB) as an investment option at its current market price. As I grow increasingly cautious about the state of both the fixed-income and equity markets, my primary concern when building positions now is value. While true value may be difficult to find, I am focusing especially on relative value. This includes looking at what sectors seem underpriced compared to the market, where growth opportunities exist, or what individual funds in my preferred areas are trading at lower premiums than their peers. This last point brings me to NBB specifically. I continue to be bullish on the taxable muni sector, but I am generally concerned about rising valuations in the sector's most popular products. While NBB does have a premium, it is quite modest, and it is noticeably lower than its peers. Further, the fund's income stream is quite attractive, as the distribution has remained stable so far in 2020. Finally, given how yields have declined in the tax-exempt muni sector, taxable munis are now offering higher tax-adjusted yields for all but the highest income earners.

Background

First, a little background on NBB. The fund is run by Nuveen and its primary objective is "current income through investments in taxable municipal securities." Currently, NBB trades at $22.86/share and yields 4.95% annually, paying monthly distributions. This is my first review of NBB, as I typically write about (recommended) the BlackRock Taxable Municipal Bond Trust (BBN) as a way to play the taxable muni space. This is a fund that has performed quite strongly since recovering from the March lows, and is actually up almost 22% since my last buy rating, as shown below:

Source: Seeking Alpha

Given my prior preference for BBN, coupled with its strong return, it may seem odd that I am branching out to NBB at this time. However, with the market continuing to push higher, in what I view as an unsustainable move, I am keenly focused on relative value for new positions. As such, NBB entered my radar as it is a similar fund to BBN, but has some advantages right now, which I will discuss in detail below.

Why Taxable Munis - Relative Value

To begin, I want to touch on the broader taxable muni bond sector, and why I feel it is a smart bet at the moment. For muni investors, they have two primary choices, tax-exempt and taxable, before then deciding if they want to focus on a particular state, type of issuance (revenue or general obligation), or credit rating. As a long-term muni investor, I typically favor the tax-exempt sector, as I use this corner of the market to generate tax-free income, in lieu of savings accounts/CDs, corporate bonds, or treasury bonds, all of which pay out taxable distributions. As a working professional in one of the highest federal tax brackets, the tax-exempt income is clearly very advantageous.

With that said, I have shifted more assets over the past year into the taxable muni sector. While I have maintained my tax-exempt holdings, I have seen relative value in the taxable space, and have begun to allocate a greater portion of my portfolio towards them. The reason behind this shift is relative value, as taxable munis have comparably higher yields, and have seen their underlying values rise considerably off the Q1 lows. The demand for these products has been driven by ultra-low interest rates, as well as aggressive foreign demand (foreign investors are agnostic towards tax-exempt munis since they don't pay U.S. taxes).

While both of these factors remain in place, the relative value aspect comes in when we look at yields on tax-exempt munis. As demand for this asset class has also soared, yields have hit historically low levels, as shown below:

Source: Yahoo Finance

Clearly, this is an important consideration. While tax-exempt munis often offer a lower income stream than taxable munis, the advantage still rests with tax-exempt bonds once the yields are adjusted for tax rates. However, as tax-exempt yields have declined, this historical norm has begun to shift. In fact, for the majority of tax filers, taxable munis now offer the best after-tax yield among a variety of fixed-income sectors, including tax-exempt munis:

Source: Charles Schwab

My takeaway here is this offers investors a clear reason to buy taxable munis given current conditions. True, the tax advantage of tax-exempt munis is still evident for those in the top federal tax bracket of 37%. But for those in the 35% bracket, the after-tax income is identical, and for everyone else (which is the vast majority of taxpayers) taxable munis are yielding more. This is a historical anomaly, and will not necessarily be the case going forward. Therefore, I see it as a clear buy signal for taxable munis, and it provides support for my continued optimism of this sector.

Why NBB - Also Relative Value

My next point touches on NBB specifically, and why I believe this is a good fund to use for exposure to taxable munis. As I noted above, I have a bullish outlook on the sector, but there are multiple funds to choose from that have similar characteristics. In the past, BBN has been my preferred choice, and I remain long on the fund today. However, BBN, as well as another peer, the Guggenheim Build America Bonds Managed Duration Trust (GBAB), both have premiums that are above their historical averages. While NBB also has a premium price, it is markedly lower. Therefore, while I see taxable munis having relative value as a whole, I see NBB having relative value within the taxable muni sector. To see why, consider the chart below:

Fund	Leverage %	Premium	Yield
NBB	36%	1.29%	4.95%
BBN	34%	4.22%	5.03%
GBAB*	15%	4.51%	6.27%

Click to enlarge

Source: BlackRock; Nuveen; Guggenheim

(*GBAB employs less leverage but has a higher yield due to its inclusion of high yield bonds and other assets beyond just taxable munis)

In fairness, it is wise to point out that both BBN and GBAB have higher current yields than NBB, so there is merit to buying into those funds. However, as a more conservative, value-focused investor, I think NBB's premium advantage is a more important consideration for the time being. Further, while GBAB is a peer to both BBN and NBB, it is not a pure play on the taxable muni space. It is a more diversified fund, and holds a fair amount of below-investment grade assets. This is not inherently good or bad, but it is not a characteristic I view favorably at this time. As such, I view NBB's premium spread quite favorably.

High Quality Holdings

Looking deeper into NBB, there is another reason why I am using this fund for fixed-income exposure. As my readers know, I have been taking risk off the table, and that includes limiting my exposure to high yield and non-agency debt. The muni market as a whole is skewed towards investment grade holdings, but there are still plenty of high yield bonds, as well as bonds that are not rated, in the space. Fortunately, NBB holds the majority of its debt in the investment grade categories. Further, unlike the investment grade corporate bond market, which has seen a surge in BBB-rated bonds, NBB's assets are mostly A-rated or better, as shown below:

Source: Nuveen

Ultimately, I view this positively. While munis will face financial pressure just like corporate bonds if lock-downs persist or if Covid-19 cases spike again, the highest rated munis have a strong track record of avoiding defaults. Given NBB's almost exclusive exposure to those types of bonds, I view this as a smart vehicle to hold in what is a challenging time.

Income Has Been Consistent In 2020

My final point takes a look at the income stream. As I noted above, NBB has a yield close to 5%, which is quite attractive in this environment. But as interest rates decline and state and local governments face pressure, the sustainability of this yield should be considered. Fortunately, despite all turbulence in 2020 so far, NBB has managed to keep its distribution stable. While the fund ended 2019 with a slight cut to its distribution, the payout has since remained unchanged for the calendar year, as shown below:

Source: Nuveen

My takeaway here is the distribution has been steady in a difficult climate, and I view this positively. While the income will come under pressure if state and local revenues remain subdued, I expect federal support will be robust enough to prevent a meaningful number of defaults.

Further, the income stream is going to remain attractive even if it does take a bit of a hit. The reason behind this outlook is because investors in the U.S. and around the globe are contending with an environment of rock-bottom benchmark interest rates. In fact, multiple central banks have pushed their benchmarks into negative territory. Even for those that haven't, such as in the U.S., rates are still sitting near zero, as shown below:

Source: Bloomberg

This means, in order to find income, domestic and foreign investors are forced to get more creative than traditional government bonds, and taxable munis can fit the bill. As foreign ownership of U.S. bonds continues to rise, taxable munis are likely going to play a key role in serving this demand, given their relatively higher yields than tax-exempt munis, treasuries, or investment grade corporate bonds. Thus, my outlook for NBB remains bullish for the remainder of 2020 under this environment.

Bottom line

I continue to expand on my taxable muni allocation, but with a keen eye on relative valuation. With premiums expanding across the space, NBB got my attention by having a lower premium than its rival funds, and a comparable yield. With underlying holdings backed by strong credit ratings and a steady income stream, I feel confident in the fund's inclusion in my portfolio. As such, I would recommend investors give NBB some consideration at this time.

Disclosure: I am/we are long BBN, 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.