Municipal CEF Sector Update: What We're Doing After A Roller Coaster Ride

seekingalpha03-15

DNY59 In this article we take a fresh look at the municipal fund space, with a particular focus on tax-exempt muni CEFs. The sector has gone on a rollercoaster ride with a sharp rise in yields ...

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The sector has gone on a rollercoaster ride with a sharp rise in yields ...</p>\n\n<a href=\"https://seekingalpha.com/article/4678405-municipal-cef-sector-update-what-were-doing-after-a-roller-coaster-ride\">Source Link</a>\n\n</div>\n","source":"seekingalpha_fund","html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>Municipal CEF Sector Update: What We're Doing After A Roller Coaster Ride</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nMunicipal CEF Sector Update: What We're Doing After A Roller Coaster Ride\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-03-15 11:55 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4678405-municipal-cef-sector-update-what-were-doing-after-a-roller-coaster-ride><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>DNY59 In this article we take a fresh look at the municipal fund space, with a particular focus on tax-exempt muni CEFs. The sector has gone on a rollercoaster ride with a sharp rise in yields ...</p>\n\n<a href=\"https://seekingalpha.com/article/4678405-municipal-cef-sector-update-what-were-doing-after-a-roller-coaster-ride\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"CEF","symbol_name":"Sprott Physical Gold & Silver Trust","start_time":0,"source_url":"https://seekingalpha.com/article/4678405-municipal-cef-sector-update-what-were-doing-after-a-roller-coaster-ride","article_id":"2419016994","we_media_id":null,"thumbnails":["https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1473821519/image_1473821519.jpg"],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2419016994","pubTimestamp":1710474917,"sourceInfo":{"source_id":"seekingalpha_fund","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"DNY59 In this article we take a fresh look at the municipal fund space, with a particular focus on tax-exempt muni CEFs. 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The sector has gone on a rollercoaster ride with a sharp rise in yields starting in 2022 and what looks like a blow-off top late last year after which yields have fallen and stabilized somewhat. Our main takeaways are that one, longer-dated municipal bonds look fairly attractive relative to shorter-dated munis as well as corporate bonds on a tax-equivalent basis. Two, high-yield munis are not as compelling as they have been earlier due to credit spread tightening. And three, muni CEF discounts remain attractive and are likely to tighten from here, particularly as leverage costs start to subside. Lay Of The Muni Land Let's review the relevant investment factors and whether they are favorable for muni CEFs. The first port of call is, not surprisingly, the level of yields. Here, the story is pretty good. Although yields have come off their late 2023 peaks, they are still well above the average of the last several years.   UBS If we zoom out further and look at both long-term investment-grade bonds (blue line) and high-yield / unrated bonds (orange line), we see that yields are on par with their pre-2022 peaks. In short, the absolute level of yields remains very attractive despite the recent pullback.   Systematic Income There are three related valuation metrics of the Municipal market - credit spreads, the Muni / Treasury yield ratio and the value of the tax exemption. The advantage of the credit spread metric is that it allows investors to gauge the valuation of bonds with different ratings. The credit spread picture is somewhat mixed. Higher-quality bonds such as those rated AA look relatively expensive (i.e. trading at tight credit spreads) while lower-quality bonds such as those rated Baa (i.e. BBB-equivalent or the lowest investment-grade rating rung) are not as rich.   UBS The yield ratio metric is useful in gauging the attractiveness of the higher-quality Muni market (specifically the AAA portion) relative to Treasuries. The yield ratio shows that the higher-quality Municipal market looks quite rich - it has only been convincingly lower in 2021.   UBS There are better opportunities further out the curve in longer-maturity bonds where the yield ratio is more compelling.   Raymond James Lastly, the value of tax-exemption is defined as the difference between the muni yield and its taxable equivalent yield, assuming the top federal marginal tax rate. Here we see that despite tight credit spreads and low yield ratios, the high level of absolute yields keeps the value of tax-exemption at very healthy levels. In our view, this makes up for tight spreads and the low yield ratio and, very likely, drives those two metrics below where they would be otherwise if yields were lower.   BOA Turning to the second metric - the yield curve - it is relevant for two reasons. One, it allows investors to pick and choose where in the yield curve to invest. For example, as shown below longer-maturity bonds offer significantly higher yields than medium-maturity bonds though at the cost of higher duration risk. And two, the yield curve drives the amount of additional net income that leveraged CEFs can generate on their leveraged assets. The steeper the yield curve the more net income leveraged assets generate for shareholders. The muni yield curve is more favorable than what we have in the taxable space. Most muni CEFs hold longer maturity bonds and the chart below shows that 15-year+ base muni yields trade above short-term muni rates which is the base rate for muni CEF leverage costs. In the taxable space the relevant yield curve is inverted by around 1.4% - a significant hurdle for corporate bond CEFs from the perspective of net income generation.   UBS If we look at the yield curve over time then, as the following chart shows, the yield curve (at least the 2s10s version) is both inverted and flatter than it has been historically. In short, although the net income picture of muni CEFs is not as dire as it is in the taxable bond space, it is not as strong as it has been historically. That said, it is due to improve as the Fed embarks on the rate-cutting cycle this year.   Raymond James Muni investors can choose where to allocate on the credit quality spectrum, for instance, whether to hold higher-quality investment-grade bonds and lower-quality high-yield / unrated bonds. At the moment the yield ratio between the two is relatively low, meaning high-yield muni bonds don't offer a particularly attractive yield pickup.   Systematic Income Finally, investors can allocate between corporate bonds and municipal bonds. The following chart shows that, on a tax-equivalent basis, longer-maturity municipal bonds look quite a bit more attractive than corporate bonds.   Raymond James Finally, municipal CEF discounts remain fairly wide in the context of their historic profile.   Systematic Income CEF Tool As the chart below shows the muni CEF sector discount is relatively wide in comparison to other sectors (x-axis) and that it is unusually wide historically at just a 4th percentile over this century (i.e. it has only been wider about 4% of the time).   Systematic Income CEF Tool The key takeaways here are the following. One, overall municipal yields are high in historical terms even as other valuation metrics are mixed. Two, longer maturity bonds are offering both higher yields and better valuations. Three, investment-grade munis look somewhat more attractive than high-yield / unrated bonds. Four, munis look significantly more attractive than their corporate bond counterparts in tax-equivalent terms (assuming the highest marginal tax bracket). And lastly, muni CEF discounts, in aggregate, are unusually wide, and which we suspect will tighten as leverage costs come down over time. A Note On Taxable Muni Bonds Most muni investors know that they can allocate to both tax-exempt and taxable muni bonds. Although the taxable muni sector is relatively small it does boast three CEFs - BBN, NBB and GBAB with GBAB only allocating around half the portfolio to taxable munis. Taxable munis are better options for investors in tax-deferred investment accounts. Build America Bonds or BABs are taxable municipal bonds that were introduced in 2009 as part of the American Recovery and Reinvestment Act. A recent development centers around the fact that the 35% subsidy for BABs has been reduced since 2013 through sequestration. A recent court case concluded that sequestration or spending cuts during federal government budget negotiations constituted a MAC or a material adverse change. The knock-on effect of this is a potential trigger of an issuer's right to seek an Extraordinary Optional Redemption of their bonds, something which could be damaging to holders than the more common make-whole call. There could be $20-30bn of BABs redeemed this year, accounting for 10-15% of the overall market. Some of the calls could lead to realized losses for holders. This issue could be a headwind for the sector in the coming years. Stance and Takeaways We recently reshuffled our tax-exempt muni Portfolio based on the factors discussed above. Specifically, we made three shifts - we reduced the high-yield footprint, increased the low-leverage / unleveraged fund allocation and added exposure to a relatively long-maturity target term muni CEF. Within the broader portfolio we continue to hold several CEFs. The Nuveen Quality Municipal Income Fund (NAD) remains one of our core holdings. The fund is trading at a 14.2% discount and a 5.47% yield. Despite its historic sector outperformance and an above-average yield the fund's discount is quite a bit wider of the sector average as the following chart shows.   Systematic Income CEF Tool NAD has recently hiked its distribution twice, in order to push the discount tighter. This hasn't worked yet but eventually investors are liable to notice this. If there is a downside to the sharp jump in the distribution is the fact that this has come at the expense of distribution coverage. However, it also means that the risk to the distribution from lower coverage is not as high as it would normally be given managers are hiking for other reasons. We also added to a pair of our MacKay ETF holdings - the IQ MacKay Municipal Insured ETF (MMIN) and the IQ MacKay Municipal Intermediate ETF (MMIT). This allocation ticks the higher-quality, unleveraged box given the discussion above. The two funds trade at 3.6-3.7% yields. The subadvisor MacKayShields is a long-tenured Muni manager with a strong track record. Although the yields of the funds are not particularly impressive, the allocation has as a dry-powder role given the fairly-rich valuations of high-yield munis. The BlackRock 2037 Municipal Target Term Trust (BMN) has been on our radar for some time. This fund ticks the longer-maturity, low-leverage CEF box. The fund's discount has widened relative to the sector which offers a good entry point. Its target term feature also offers a potential performance tailwind in the form of discount amortization.   Systematic Income CEF Tool We also added an allocation to the unleveraged Nuveen Municipal Income Fund (NMI). NMI trades at a 9.1% discount and a 4.72% current yield. The fund's distribution has been hiked gradually - 3 times over the past year. And unlike the net income of leveraged funds, its net income profile has been stable and actually increased recently. The fund ticks the box as far as a longer-maturity profile, something which allows it to generate a relatively high level of yields as discussed above. Its credit profile is barbelled with a 60% investment-grade portfolio and 32% in unrated bonds.    Systematic Income CEF Tool","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2419016994"}