Muni Bond CEFs: PIMCO Or Nuveen? The Choice Is Obvious In This Market Environment

Jun. 10, 2022 10:00 AM ETPMF, PML, PMX, NAD, NEA, NVG, NZF56 Comments47 Likes

Summary

  • I don't quite understand who would be buying the PIMCO National municipal bond CEFs over the Nuveen national muni bond CEFs right now.
  • These two fund sponsors of municipal bond closed-end funds are probably the two most popular when it comes to high-yields (PIMCO) and the sheer number and size of funds (Nuveen).
  • But in terms of performance and valuation, there's a big difference between the two which should be obvious to anyone who performs even basic research and due diligence.
  • So if you think a worst-case scenario is going to unfold for bonds and bond funds with the fed funds rate going to say, 3.5% in a year, then why wouldn't you choose the fund sponsor with the better valuation, better NAV performance, and lower NAV yield?
  • Investors big and small seem to think that the higher the yield, the more attractive the fund. But in difficult times like these when interest rates are rising, it's the funds with the lowest NAV yields that are FAR more likely to be able to cover those yields and sustain their NAVs.
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Page of newspaper with words municipal bonds.

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**NOTE: This article was released to subscribers of CEFs: Income + Opportunity earlier***

How is it that the PIMCO national municipal bond CEFs can have some of the highest NAV yields and yet continue to trade at some of the highest market price premiums?

Does anybody understand that the higher the NAV yield, the harder it is for a fund to cover its NAV yield? Maybe in a rate cutting environment that might make sense to go with the higher-leveraged and higher-yielding funds, but certainly not now.

And because of those high market price premiums, if you compare the three PIMCO national municipal bond funds, i.e. the PIMCO Municipal Income Fund II (PML), the PIMCO Municipal Income Fund III (PMX) and the PIMCO Municipal Income Fund (PMF) with the four largest Nuveen national municipal bond funds, i.e. the Nuveen AMT-Free Quality Municipal Income Fund (NEA), the Nuveen AMT-Free Muni Credit Income Fund (NVG), the Nuveen Quality Municipal Income Fund (NAD) and the Nuveen Municipal Credit Income Fund (NZF), the end result is that their market yields are really not that much different than the PIMCO funds currently.

Data is as of 6/9/22:

PIMCO vs Nuveen muni bond stats

But the fact of the matter is that if a worse-case scenario does arise and short rates rise up to 3.5% or higher, the PIMCO muni bond CEFs are going to be in a FAR more precarious position of trying to cover their NAV yields than the Nuveen muni bond CEFs.

Keep in mind that we are dealing with municipal bond CEFs that are highly leveraged, which is what most fixed-income CEFs use. Non-leveraged CEFs will certainly be less volatile but will generally not offer near as high of a tax-equivalent yield.

For example, a 5% Federal tax-free municipal bond yield could mean as high as an 8%-plus tax-equivalent yield depending on a filer's tax bracket.

Also, this analysis does not take into account each fund's unique portfolio of securities, credit quality, duration or any other variables that municipal bonds include.

But sometimes, you can just disregard all of that and simply compare the funds where the rubber hits the road. And that's NAV total return performance taking into account all distributions.

Let's first look at a one-year total return at NAV for all seven funds:

1-year PIMCO vs Nuveen muni bond performances

Here we can see that all are negative, which is not a surprise, but the 4 Nuveen funds are clearly beating the PIMCO funds by quite a margin. 200 to 300 bps, or a 2% to 3% difference is HUGE when it comes to municipal bond performances over a year's time, even when using leverage.

Certainly, PIMCO's higher use of leverage has probably contributed to their poorer performance as municipal bond prices have fallen extremely hard but what if we go back three years in which interest rates were more benign to even supportive of municipal bond prices?

Well, here is a three-year NAV total return performance graph:

3-year PIMCO vs Nuveen muni bond performances

Once again, all four Nuveen funds come out on top with (NZF) actually positive over this time frame which includes COVID-19. And the outperformance by Nuveen over PIMCO over this three-year time frame is more like 300 to 400 bps, or 3% to up to 4%.

Conclusion

The bottom line is that we don't know how high short-term rates are going to go with 50 bp rises now expected from the Federal Reserve in June and then again in July but after that, it really depends on how the economy and inflation react.

But make no mistake. The top four Nuveen national municipal bond CEFs are going to be in a MUCH better position to ride out a worse-case scenario than the PIMCO municipal bond funds.

Though I have no control over where investors will take these fund's market prices if that occurs, what matters is the NAV and from that standpoint, your best bet is to stick with the Nuveen funds.

Thank you for reading my article. My goal is to give you observations and actionable ideas in Closed-End funds while educating you on how these unique and opportunistic funds work.

CEFs can be one of the most exhilarating and yet most frustrating security classes to invest in, and it's important that you have someone who can be a level head during up and down periods of the market. I hope to be that voice of calm when necessary.  ~ Douglas Albo

This article was written by

Douglas Albo profile picture
11.37K Followers
Looking for equity CEFs with the best income and appreciation potential.

Registered Investment Advisor since 2009. Prior experience includes 12-years as a Vice-President, Financial Advisor at Smith Barney from 1994 to 2001 and Morgan Stanley from 2001 to 2007.

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Disclosure: I/we have a beneficial long position in the shares of NZF, NEA, NVG either through stock ownership, options, or other derivatives. 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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