Bond funds are offering a ‘double whammy’ for investors
18 hours ago
These funds are worth a closer look. - Getty Images
Closed-end bond funds, long a staple investment for retirees and those seeking income from their investments, have been left in a fire-sale environment by the four-month slump in the bond market.
A perfect storm of falling bond prices, higher leverage costs, investor capitulation and tax-loss harvesting at the end of 2024 have left many of these funds now trading at deep discounts to their underlying net asset value, and with distribution yields that may look tempting.
Thirty of these funds have been left selling for 90 cents or less for each dollar of investments, and 23 paying out distribution yields of 5% or more, as of Tuesday night’s close.
Whether these turn out to be a bargain can’t be said for certainty except in hindsight. But if Wednesday’s rally marks the end of the bear market in bonds, investors buying into the right closed-end funds could be setting themselves up for a double win: The underlying net assets of the funds would rally with the bond market, while the share prices of the funds themselves would rise even more as the discounts to net asset value rally.
“Bonds have gone nowhere for years,” says Larry Glazer, managing partner of Mayflower Advisors in Boston. “The recent increase In interest rates and poor sentiment in the bond market have created a double whammy on closed and funds, and a buying opportunity for many.”
To add a further complication, many of these funds are leveraged: They borrow money at short-term rates to buy long-term bonds. So if the Fed resumes cutting rates any time soon the funds would get a triple win: The bond investments would rise, the share price would rise still further, and the debt costs would plunge.
But all of this works in reverse as well. If bonds keep falling, and the Fed hikes short-term rates, these funds’ net assets would get a kicking.
Closed-end funds are regulated mutual funds that trade on the stock market like better-known exchange-traded funds, but with one key difference. Closed-end funds do not vary the amount of fund shares in issue from day to day, depending on demand. Instead they typically issue a fixed amount of shares in an IPO, like a publicly traded company, and those shares then change hands between buyers and sellers. This means that the share price moves independently of the underlying net asset value of the fund’s shares.
AllianceBernstein National Municipal Income Fund AFB, a $590 million national muni fund, fell to 88 cents on the dollar—a 12% discount—with a 3.9% distribution yield. (The distribution yield for closed-end funds, typically paid through monthly dividends, can include some return of capital as well as bond income.)
MFS Municipal Income Trust MFM, a $370 million national muni fund, fell to 89 cents on the dollar. The trade organization, the Closed End Fund Association, estimates the distribution yield at 4.65%.
BlackRock Muni Quality Yield II MQT, a $390 million national muni fund, also fell to 89 cents on the dollar, while the shares offered a distribution yield of 6.2%—although this includes substantial return of capital as well as income.
Neuberger Berman Municipal Fund NBH, a $590 million national muni fund, fell to 88 cents on the dollar with a 6.4% distribution yield, which also includes substantial return of capital.
These are illustrations rather than recommendations. All four funds have outperformed the low-cost industry benchmark, the iShares National Municipal Bond ETF MUB, over the past 15 years.
BlackRock’s 2030 Municipal Term Fund BTT, a $2.4 billion fund, is due to wind up at the end of 2030 and return $25 in principal to each stockholder. Yet it is now selling for just $20.77 per share, which is 87% of net asset value and 83% of the expected liquidation value. It is also paying an income yield of 2.7%.
As these funds own municipal bonds, their income is largely exempt from federal income taxes, although there may be some Alternative Minimum Tax on some of the income due for higher-income investors.
The big discounts aren’t reserved to muni funds.
For example, Western Asset Inflation-Linked Opportunities and Income Fund WIW, an $840 million fund largely invested in inflation-protected Treasury bonds, is at 87 cents on the dollar with a distribution yield, including return of capital, of just under 9%. (The yield from income alone is 3.4%). Bill Gates has been a long-term investor in the fund and owns 23%.
“It’s unusual that you could buy a dollar’s worth of assets for 85 cents and that’s exactly what’s happening with closed end funds,” says Larry Glazer. “Closed end bond funds are a tactical and timely way to take advantage of dislocation in the bond markets. Year-end tax-loss selling dynamics only exaggerated this situation and enhance the opportunity.”
Naturally investors need to do their own homework and accept that while the market often offers you a good deal, it rarely offers you something for nothing. Caveat investor, as always.
