By
John Cole
Scott
:
The largest major grouping in the closed-end fund ((
CEF
)) universe is the municipal or tax-free bond investment objective.
The group has 220 of the total 600 U.S. listed funds (36.7%) or
$89.4 billion of the total $261.3 billion (34.2%) assets held by
all closed-end funds. There are 103 national muni funds and 117
state specific muni funds for investors to choose. All data unless
otherwise noted is from our weekly CEF Universe data service dated
November 30, 2012.
While discounts in the municipal sector have been hard to come
by recently, we feel the benefits of closed-end funds, the fixed
capital for the investment portfolio and the use of cheap leverage,
currently make municipal CEFs more attractive for many investors
than the open-end, exchange-traded and individual bond holdings
options in terms of both dividend yield and total return
performance.
It should be noted that due to the effects of both leverage and
market liquidity, investors should expect more volatility in a CEF
than other investment options. One way for investors to use this to
their benefit is by utilizing limit orders and to take patience and
diligence entering and selecting points to purchase or sell shares
in a CEF. If readers are not familiar with our firm's data points,
there is a link to our data definitions page at the end of the
article.
In the past year, the average CEF discount for national
municipal bond funds has traded between -4% and +2% to net asset
value ((
NAV
)). Though trading above NAV has been normal for many funds during
the past year, the average forward indicated yield for these funds
has slowed due to strong performance of the underlying bond
portfolios, with the average national municipal bond CEF up almost
+18% year-to-date on a total return basis through November 30,
2012. Because municipal funds have done so well for the past few
years, we believe investors need to be very cautious about
monitoring the fundamental data for their holdings to anticipate
dividend changes as well as fluctuations to the fund's NAV
performance when interest rates eventually rise.
Swapping similar funds regularly can help increase the
investment allocation's performance over time, though this cannot
be guaranteed. One way to do this is to sell a municipal bond fund
if it trades above the peer group average discount/premium and to
buy a peer fund if it trades below the peer group average disc/prm.
This strategy works as long as both the NAV and the dividend rate
of the replacement fund do as well as those of the original fund.
Also, funds more likely to increase vs. cut a dividend can help an
investor's income grow over time and potentially hedge against
inflation.
(click to enlarge
)
One concern we have is that the typical municipal CEF has a
declining trend in the UNII balance over the past year. We not only
track the current amount of UNII in cents per share on the fund's
balance sheet, but also the previously announced UNII figures, so
that we can determine a trend.
We use 90-day correlation data to help identify how much a
fund's recent price movement is due to the NAV movement vs. how
much of it is due to investor's perceptions on the fund's future
value or dividend levels.
Research Screening Premise:
In making the two lists of funds below, we reviewed the
following data in order to try to identify the funds most likely to
experience a dividend increase or decrease in the near future:
undistributed net investment income (UNII), relative UNII, UNII
trend, earnings coverage, earnings trend, having UNII/earnings data
updated at least since 9/30/12, as well as having at least one year
since the fund last announced a dividend change. We also screened
for funds with liquidity above $500K a day to increase the
likelihood that they were CEFs that investors might hold or could
potentially purchase without moving the market price too
aggressively.
(click to enlarge)
(click to enlarge)
Note: The funds above have a positive relative UNII cushion,
however, we are concerned with these funds because the earning
coverage is well below the dividend policy and they have both a
UNII and earnings trend that is negative.
Predictive Data for Dividend Changes
CEFA is currently working on a research project to confirm the
predictive value of UNII and earnings information for future
dividend cuts and increases. While we expect it to take a few more
months to have conclusive data for all CEF groups and all data, one
data point is currently looking very promising.
Between September and November 2012, of the 15 dividend cuts for
municipal bond funds where we have a UNII trend available, 100% had
a negative UNII trend. We hope this gives investors reason to
review the financial statements for their CEF holdings.
CEFA's Municipal Bond CEF Tips:
- Try to buy municipal CEFs that meet the following criteria:
- Lower than peer group average discount or premium
- Updated its UNII and Earnings data in the last 90 days
- Positive Earnings & UNII Trend
- Earnings Coverage over 100%
- NAV Performance above Peer Average
- Duration, Credit Quality and AMT% Exposure that meet your
investment objectives
- Enough liquidity to meet your trading expectations
CEFA's
Data Definitions - pdf
Disclosure:
I am long [[MUA]]. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
this article.
Additional disclosure:
Disclosures: CEFA has client positions in MUA as of the writing of
this issue. The information and statistical data contained herein
have been obtained from sources that Closed-End Fund Advisors
((CEFA)) believes are reliable, but CEFA makes no representation or
warranty as to the accuracy or completeness of any such information
or data and expressly disclaims any and all liability relating to
or resulting from your use of these materials. The information and
data contained herein are current only as of the date(s) indicated,
and CEFA has no intention, obligation, or duty to update these
materials after such date(s). These materials do not constitute an
offer to sell or the solicitation of an offer to buy any
securities. CEFA may make decisions for its clients in certain of
these securities. CEFA and/or their respective officers, employees,
and affiliates may at any time hold positions in any of these
securities and may from time-to-time purchase or sell such
securities.
See also
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