The municipal bond market saw an impressive run during the first half of 2016, but munis have stalled over the past few months. This could be attributed to multiple reasons, such as the next U.S. President’s tax plan and the potential rise in interest rates. We’ve seen a sell off in some municipal bond funds over the recent months due to interest rate hike fears, but that’s unwarranted.
Rate Hike in November? Highly Unlikely.
According to the CME Group 30-Day Fed Fund futures price, which is an indication of the probability of changes in the U.S. Fed Funds rate, shows that market participants are expecting rates to remain unchanged at 25 bps to 50 bps in the FOMC’s November meeting.
The Fed released minutes for its September FOMC meeting and indicated that it was a close call whether it would hike rates in September. However, it was a 7-3 vote, and we’ll most likely see an unchanged Fed Funds rate in November due to the U.S. Presidential election because the FOMC doesn’t want to spook the markets. Although the minutes noted that FOMC participants an interest rate hike could occur “relatively soon”, committee members would need to see strong economic data within the next few weeks before even considering a rate hike.
That being said, market participants are looking for the Fed to raise rates in December, but only the FOMC knows what it’ll do, in regards to monetary policy. If the FOMC decides on a rate hike, yields shouldn’t jump too high. Consequently, the selloff in the munis market has uncovered some buying opportunities. Munis are undervalued, when compared to U.S. Treasuries, and you should consider these municipal bond funds and trusts before opportunities dry up.
I’ve had a lot of success buying the panic when it comes to sell offs in closed-end funds and also MLPs over the years. I think right now is an ideal time to give this group a look. Below are 6 ideas that I’m focused on right now. I personally own MEN, MHI, BFK, BBN, NUV already and am waiting to add more if they dip further.
Pioneer Municipal High Income Trust Fund
Pioneer Municipal High Income Trust Fund (NYSE: MHI) is a CEF that aims to provide a high degree of current income that is tax exempt from federal income tax, while the traditional U.S. Treasuries fund is usually taxed at both the federal and state level. The fund primarily holds municipal securities in the health, special revenues, education, various revenues and general obligation sectors. Additionally, approximately 50% of the municipal securities held have call dates and maturities under five years.
According to the fund’s last monthly report, it had a distribution rate of 5.08% and a taxable-equivalent yield of 8.97%, as of August 31, 2016. The fund saw large outflows over the past few months, and it’s down 9.08% over the past trailing three-month period, as of October 18, 2016. Moreover, the fund is trading at a 4.66% discount, when compared to its last reported NAV. Consequently, MHI should bounce back soon as more investors and traders find out its undervalued.
BlackRock Taxable Municipal Bond Trust
The BlackRock Taxable Municipal Bond Trust (NYSE: BBN) aims to provide a high degree of current income and capital appreciation. The trust primarily invests its assets in taxable municipal securities, but can invest up to 20% of its managed assets in other securities, such as tax-exempt securities. The fund’s top five sector exposures are: 26.91% utility, 20.30% local tax-back, 15.70% state tax-backed, 15.33% transportation and 8.62% education.
As of October 17, 2016, BBN had a distribution rate of 7.05% and a yield to worst of 4.96%. Additionally, it had an average coupon of 10.92%. BBN provides attractive yields, when compared to U.S. Treasuries funds. However, BBN would be a better investment right now. Despite BBN’s share price falling 5.01% over the past three months, it’s still up 13.09% year to date. The trust is currently trading at a 6.01% discount, and you should keep an eye on this fund because it’s poised to bounce soon.
BlackRock MuniEnhanced Fund, Inc.
The BlackRock MuniEnhanced Fund, Inc. (NYSE: MEN) provides investors with a high level of federally tax-exempt income. To achieve this, it invests at least 80% of its total net assets in federally tax-exempt munis. The fund holds a diversified portfolio of assets that are investment grade and a majority of the munis have a maturity of over 10 years.
The fund currently offers attractive yields and investors shouldn’t be fearful of the potential rate hike in December because yields probably won’t move too much. As of October 17, 2016, MEN had a distribution rate of 5.76%, an average coupon of 4.23% and a yield to worst of 2.93%. Since the fund primarily invests in federally tax-exempt munis, it has an attractive taxable equivalent yield of 8.86%. The fund sold off by 5.34% over the past three months and is currently trading at a 2.68%. Therefore, the panic outflows in the fund provided buying opportunities in MEN.
Deutsche Municipal Income Trust
The Deutsche Municipal Income Trust (NYSE: KTF) is another fund that provides a high degree of federally tax-exempt current income. To achieve this objective, KTF primarily invests in a diversified portfolio of investment-grade and federally tax-exempt munis securities.
The fund currently has total net assets of $544 million and 195 holdings with a modified duration of 7.37 years. The Deutsche Municipal Income Trust is heavily weighted towards revenue bonds, with 71% of its portfolio allocated to the sector. Only 14% of its portfolio is allocated to the ETM/prerefunded, 10% to general obligation bonds and 5% lease sector.
Like many other funds in the muni national long category, KTF saw a sell off. Over the past month, KTF’s share price fell by 5.93%. However, KTF is still up 4.51% year to date. Although KTF is trading at a slight premium to its NAV, the fund provides a better opportunity and more attractive yields than U.S. Treasuries. The fund has a market price yield of 5.81% and NAV yield of 6.07%. However, since the fund primarily hold tax-exempt munis, based on the highest federal income tax level, it had a market price tax-equivalent yield of 10.27% and net asset value tax-equivalent yield of 10.72%, which is a lot higher than what U.S. Treasury funds are offering.
Eaton Vance National Municipal Income A
The Eaton Vance National Municipal Income Fund A Shares (EANAX) is a mutual fund that provides diversified exposure to the municipal bond market and aims to provide a high level of federally tax-exempt current income. EANAX as total net assets of $3.2 billion and had a one year return of 7.68%, based on its last quarterly report.
The fund holds over 200 municipal bonds that are mainly investment grade. The portfolio has an average coupon of 5.55%, average effective maturity of 7.85 years and average duration of 5.24 years. EANAX holds municipal bonds in multiple sectors ranging from general obligations to electric utilities.
Although the Eaton Vance National Municipal Income Fund did not fall as much as other municipal bond funds, EANAX fell by 1.01% over the past month and 0.80% over the past three months. As of October 18, 2016, the fund had a trailing 12-month yield of 3.76% and 30-Day SEC yield of 1.76%. Since EANAX primarily holds municipal bonds that are tax exempt at the federal level, it had a trailing 12-month yield of 6.65%, based on the highest tax bracket.
The unjustified selloff in the munis market uncovered another opportunity that investors and traders could exploit because the rate hike fears shouldn’t arise until the Fed says gives a timetable of when it’ll raise rates.
Nuveen Municipal Value Fund, Inc.
The Nuveen Municipal Value Fund, Inc. (NYSE: NUV) provides current income that is tax exempt at the federal level. To achieve this, the fund selects and holds tax-exempt bonds. The fund provides an attractive monthly tax-free income, when compared to U.S. Treasury funds. The fund currently has $2.18 billion in common net assets and 440 holdings.
NUV’s top five sector allocations are 19.7% tax obligation/limited, 17.6% health care, 17.2% transportation 12% U.S. Guaranteed and 11.7% tax obligation/general. The fund primarily holds investment-grade bonds, with over 75% of its portfolio allocated to A, AA and AAA based on the Standard & Poor’s Group credit ratings scale. The portfolio has an average coupon of 3.47% and an average effective duration of 7.08 years.
Although interest rate hike fears should be muted for at least another month, NUV fell by 4.46% over the past month, as of October 18, 2016. Moreover, the fund is trading at a 3.85% discount to its NAV, indicating there are buying opportunities in the fund. The fund had a distribution rate of 3.90% and had taxable-equivalent yield of 6.89%, as of October 18, 2016. NUV provides higher yields and is undervalued, when compared to U.S. Treasury funds, such as the iShares U.S. Treasury Bond ETF (NYSEARCA: GOVT).
These type of opportunities don’t last long.
The November FOMC meeting is around the corner, it won’t won’t be long until market participants get the gist that Fed is unlikely to raise. With that said, if you’re in the same camp we’re in, then the time to act is now.