Muni Closed-End Funds Yield Over 4%, Now at Big Discount to Portfolio Values

Leading funds ranked by size include
Nuveen AMT-Free Quality Municipal Income
(Ticker NEA),
Nuveen Quality Municipal Income Fund
(NAD),
Nuveen AMT-Free Municipal Credit Income
(NVG) and
BlackRock
 
Municipal 2030 Target Term
(BTT).

Closed-end funds issue a fixed number of shares and can trade at a premium or discount to their portfolio value, or net asset value, depending on investor demand. They trade like stocks, mostly on the NYSE.

One factor behind the discounts is widespread dividend cuts which has prompted selling by retail investors, which are a big factor in the market. The dividend cuts have been driven in part by higher short-term rates, which boost the interest costs of leveraged closed-end funds that dominate the sector.

The yields of around 4% are higher than those on long-term Treasury bonds and are tax-free—investors, however, may be subject to state taxes on out-of-state income. The yields do come with risk due to the leverage on the funds, which magnifies gains or losses on the underlying bond portfolios.

The muni funds appeal to Matisse Capital, which runs the
Matisse Discounted Closed-End Strategy
(MDCEX) and Matisse Discounted Bond CEF Strategy (MDFIX), mutual funds that invest in discounted closed-end funds.

Eric Boughton, a portfolio manager at Matisse Capital, which runs the funds, says municipal bonds are apt to be a good investment over the next five years and that for an “investor willing to do a little more work and own highly discounted municipal bond closed-end funds, the returns should be higher.”

Muni closed-end fund prices are above their October lows but remain well below 52-week highs. Investors have been stung by dividend cuts throughout the sector. Most muni closed-end fund use leverage to boost yields. Higher muni short rates, which recently hit 4%, up from under 1% a year ago, have crimped the spread that the funds earn on the portion of their portfolios financed with debt or preferred stock.

The $3.3 billion Nuveen AMT-Free Quality Municipal Income, the largest muni closed-end fund, has cut its dividend by about a third in the past year and now yields 3.8%. The Nuveen AMT-Free Municipal Credit Income, which holds lower-quality munis, now yields 4.4% after reducing its dividend also by a third.

BlackRock Municipal Target Term 2030 now yields 3.2% and trades at a 10% discount to its net asset value. Now changing hands around $21.40, it aims to return $25 to holders in 2030. That looks achievable with a current net asset value of nearly $24 a share. If the fund delivers $25 to investors in 2030, the effective yield should be nicely above 5%.

On dividend cuts, here’s what Boughton tells Barron’s in an email: “We’ve already seen sizable reductions for most funds as they adjust to the new borrowing rates and the realized yields in their portfolio…Muni CEF dividend cuts are likely to be largely in the rearview mirror.”

Some investors don’t like muni closed-end funds due to their high fees. But Boughton says the average management fee is 0.55% annually. Total fees displayed on websites may include the cost of leverage, which really isn’t a fee.

 “It is indeed not very useful for most purposes to count the cost of leverage as an expense, especially when it tends to add to, not detract from, total returns,” Boughton says.

Write to Andrew Bary at [email protected]