CEF穆尼市场更新|2019年9

The muni CEF market remains a hot sector with discounts relatively tight and yields lower. Nine months ago, 5.0% yields were fairly common. Today, yields are materially lower.

Munis have seen a significant amount of fund flows this year as investors play a bit of defense.

The big risk is if the market does see a rotation into the reflation trade again boosting long-term rates and reducing NAVs.

But just remember the role that munis should be playing in your portfolio. They are a natural hedge investment, meaning that they tend to go up when other riskier assets drop in price.

Rank of Best Buys Today

(1) Top Funds Fundamentally

(2) Top Funds on Valuation

(3) Removing/On Watch

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We have discussed the idea that interest rates have bottomed and could back up a bit given how crowded and overbought long-bonds had become. Some of that is starting to play out, though I'd be hesitant to say the reflation trade of the last few years is back on.

For the last 9+ months, the municipal bond market has generated strong and consistent monthly performance. The Barclays Muni Bond Index is up 5.78% year-to-date having peaked in mid-August around 6.4%. In the chart below, we plot the 30-year Treasury yield (in orange) against the

SPDR Nuveen Bloomberg Muni Bond ETF (

)

. It is evident that the reversal in rates with the 30-year moving from a low of 1.90% to over 2.11% has slowed the muni rally.

Data by YCharts

The recent underperformance of munis relative to Treasuries has helped to reset valuations a bit to more attractive levels. In addition, the technical backdrop has not changed. The demand for tax-exempt income in order to reduce tax burden continues unabated. Fund flows into muni funds have been incredible.

The image below shows the steady new monthly inflows into muni funds since the start of 2019. The rolling 12-month average has been very strong with new supply of $198.7B in the first seven months of the year, up 3.3% from the same period last year. The muni space has seen 35 straight weeks of inflows - on pace for the best year for fund flows on record.

(Source: Legg Mason)

Muni ratios are pointing to fairly attractive valuations at the moment. The 10-yr AAA muni to US treasury ratio was 83% at the end of August which is up for the third straight month but still historically low compared to longer-term averages.

We would note that the month of September is typically when the market's net negative supply turns positive. However, primarily due to tax loss harvesting and other factors, the weakest months for munis tends to be October and November.

(Source: Nuveen)

With investor sentiment improving over the trade issues, yield rose and could rise further should additional mitigation on that front be produced. The US appears unlikely to enter a recession in the next six months and thus we have been stating that the rate drop - some of which is simply globally induced - is overdone. In other words, we could see some NAV headwinds as interest rates inch back higher.

We don't think we are in the same environment we were in from 2015 to 2018 when the yield curve was shifting up (all maturities were going up in yield). Instead, we think the slope of the yield curve could steepen a bit with short rates coming down and long-rated inching higher. This is a good long-term outcome for investors as leverage costs are reduced and called/maturing securities in the fund can be replaced by higher coupons.

Leverage costs have been inching lower since March with the SIFMA index down to 1.28%. Since the start of the year, the index is down more than 25%. In other words, leverage costs, generally speaking, are down about a quarter.

The average yield across ALL muni CEFs (n=150) is down to 4.1%. At the start of the year, that yield number was around 4.5%. The average discount has stabilized in the last few weeks and remains around -4.6%, about 80 bps wider than a month ago.

Our screening process essentially whittles down the entire universe of muni CEFs using a handful of fundamental drivers. We can then use that reduced universe to overlay a valuation framework and select the best using a point system. There are 148 muni CEFs when excluding the taxable munis. The screening process typically gets that number down to about 30 funds (give or take) by applying filters on certain parameters.

Those include:

Quick Fundamental Summary

Nuveen: All conviction funds (NAD, NMZ, NEA) did well again in July and improved their UNII balances for the 13th straight month.

Outside of the conviction funds, we think there are some decent funds that could be looked at and a few others that are in trouble.

Top funds: NMZ (yield 4.96%), NAD (yield 4.42%), NEA (yield 4.46%)

BlackRock:

Conviction funds all did well, and distribution cuts from June are now reflected in the July coverage ratios.

Outside of the conviction funds, there are possibly some others that could be interesting and others we would avoid.

Top funds: MQY (yield 4.25%), BAF (yield 4.31%), BKN (yield 4.33%)

Other Funds

State-Specific Funds

These are funds we think you can buy today at current prices.

(1) BlackRock MuniYield Quality

Right now, this is the best of the best among the BlackRock funds with strong coverage following the recent distribution cut (103%+). It also has positive and growing UNII balances. The yield is slightly lower at 4.25%, but that is okay given the higher-quality portfolio (all investment grade). The call schedule is very favorable with just 4.7% in the next year being callable. After that, 4.33% for 12-24 months, and 6.3% for months 24-36. This is literally one you can buy today and hold for a number of years.

(Source: BlackRock)

(2) Invesco PA Value Muni

This is not a new fund, but one that corrected following the long expect distribution cut. This is the second cut since April with the distribution rate coming down a full penny (-16.7%). Most recent EPS is $0.0495 (three-month avg is $0.0485), so the new distribution of $0.0483 allows a little cushion for more calls. UNII is $0.02915 and trending lower, but I would expect that to slow or reverse with the latest cut.

The call schedule shows just 3.07% for 2019 and is fairly benign thereafter.

(Source: Invesco)

(3) BlackRock MuniHoldings NJ Quality

We recommended this fund last month, and it is still in the "green" on the sheets. The yield is up to 4.43% as the price has moved down - and much more than the NAV. The discount is now near -12%, another 100 bps from last month. Nothing fundamentally has changed in the last month, and the call schedule (recently released through August) improved slightly in the one-year period.

(Source: CEFConnect)

The market right now is going through a rotation that is moving back to the reflation trade. This was the same "trade" that we experienced from the middle of 2016 through most of last year. It led us to implement our three-legged stool strategy (for those older members) to combat the threat of rising rates. Those stool legs stood for floating rate, hedged fixed income, and short duration high yield.

The current reflation trade is unlikely to last as long as the last round. In fact, we think it will be measured more in weeks or a few months rather than years. Still, for as long as it lasts, longer duration assets will underperform. That includes muni bonds, preferreds and REITs not to mention the growth/momentum stocks. But we are not selling, but simply restraining our buying at this point to see if we find a bottom first.

But just remember the role that munis should be playing in your portfolio. They are a natural hedge investment, meaning that they tend to go up when other riskier assets drop in price. It is also an election hedge as well as the potential for higher taxes would almost assuredly drive more investors towards tax-free bonds.

I am/we are long MUNI CORE.

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.