Closed-End Muni Funds Now Trade at Biggest Discount in 18 Years

Over the past year, the average muni closed-end fund discount has been closer to 10% and the long-term average is around 5%.

The Nuveen AMT-Free Quality Municipal Income Fund yields 4.3% while the Nuveen AMT-Free Municipal Credit Income Fund, which has a sizable chunk of its assets in bonds with lower credit ratings or none at all, yields 5%. The average muni closed-end fund yields almost 5%.

A 5% rate on munis is equivalent to a yield of about 7.7% on a taxable bond for an individual in a 35% federal tax bracket—not factoring state taxes, which can lift the taxable-equivalent yield to over 8%. That is close to the average yield on junk bonds.

“Long-term rates have moved up and it’s causing investors to panic out of long-duration assets,” says Eric Boughton, a portfolio manager at Matisse Capital. ‘It’s a huge opportunity in muni closed-end funds. 

His firm runs the
Matisse Discounted Bond CEF Strategy
(MDFIX), an open-end fund that buys discounted fixed-income closed-end funds. 

The fund now has about a 50% weighting in muni funds, double its normal allocation. Its largest muni closed-end fund holdings include the
Abrdn National Municipal Income Fund
(VFL) and
Nuveen Municipal Credit Income Fund
(NZF). Four of its five largest muni holdings have discounts of 16% or more.

One muni closed-end fund that is worth a closer look by investors is the
BlackRock Municipal 2030 Target Term Trust
(BTT), trading around $19.30 with a 13% discount to net asset value. 

While its dividend yield is relatively low at 3.5%, it aims to return $25 a share to investors in 2030. If that happens—or if the payback is even close to $25—investors could earn a 7% annualized return, Barron’s estimates. Most muni closed-end funds have no wind-up date. 

Muni closed-end funds have been hard hit because they have experienced a triple whammy. 

The funds tend to own longer-term municipal bonds with maturities of 15 to 20 years, which have been hit by the recent selloff in fixed-income markets. The funds are leveraged, often with about 50 cents of borrowings for every dollar of equity, magnifying losses in a down market. 

And sharply higher short-term rates are cutting the rate spreads that the funds earn on the leveraged portion of their assets. 

The muni short-term rate benchmark, known as Sifma, has risen to about 4% from near zero in early 2022. With muni bonds yielding in the 4% to 5% range, the benefits from borrowing are largely negated.

This has contributed to widespread dividend cuts among muni closed-end funds.

The Nuveen AMT-Free Quality Municipal fund’s dividend, for instance, has fallen by about 40% since early 2022 to an annual rate of 42 cents per share. 

One problem for investors in muni closed-end funds is that fees can be ample at around one percentage point. For funds to offer competitive dividends relative to other muni investments such as individual bonds and exchange-traded funds, they often need to trade at discounts to net asset value. 

For instance, a Los Angeles airport 5% bond due in 2052 now yields about 5%. That is a nice yield for an AA-rated bond and offers competition for muni closed-end funds.

It has been difficult for activists to try to turn closed-end funds into open-end funds, which would collapse discounts and benefit investors.

Still, the wide discounts on muni closed-end funds offer attractive yields and better liquidity than individual munis that are traded in an over-the-counter market. Given their leverage, the funds should appreciate nicely if long-term rates head back down.

Corrections & Amplifications

A Los Angeles airport 5% bond is due in 2052. An earlier version of this article incorrectly said the bond was due in 2022.

Write to Andrew Bary at [email protected]