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Volatility Pummels Closed-End Funds

Unusually high volatility levels in recent months helped push down Ratings grades of the closed-end municipal bond fund group, normally a relatively calm sector.

This volatility was a prime factor in closed-end tax-exempt bond funds dominating the "Most Deteriorated" grouping of the accompanying table of the biggest recent closed-end fund ratings grade changes.

Three of the muni funds in the table's bottom grouping experienced grade changes that demoted them from hold status to sell recommendations. One skidded from buy-recommended territory to a hold recommendation while the fifth, the Neuberger Berman California Intermediate Muni Fund (NBW), slipped from a buy recommendation that was appropriate for its former grade of A- to a weaker buy in line with its April 30 grade of B-.

Uncharacteristically high volatility of returns has plagued the muni funds for months. Concern about the credit ratings of bond insurers, resulting from the credit crunch, were compounded with doubts about exemption of municipal bond dividends from state income taxes.

But a recent U.S. Supreme Court decision to maintain state income tax exemptions is likely to calm the market and reduce the unusual volatility of the funds.

The suffering of leveraged closed-end bond funds has been amplified by turmoil in the auction-rate securities market.

Despite their downgrades, all five of the closed-end muni bond funds in the "Most Deteriorated" list are ahead for the year to date, with the Eaton Vance Insured Pennsylvania Muni Bond Fund (EIP) up an impressive 7.56%.

The "Most Improved" section of the adjoining table is headed by the Nicholas-Applegate International & Premium Strategy Fund (NAI), which vaulted from a grade by Ratings of E+, in sell-recommended territory, to a buy-recommended mark of B-. The fund's largest holdings are Telefonica (ADS) (TEF - Get Report), Nokia (NOK - Get Report) and Royal Dutch Shell (ADS Class A) (RDSA).

The Nicholas-Applegate International fund is kept company on the "Most Improved" roster by another closed-end entry with international focus, the Clough Global Equity Fund (GLQ). It advanced from a sell recommendation to a status of hold and a grade of C+ by Ratings. With 63.4% of its holdings invested in U.S. securities, the largest stockholdings of the fund are Intel (INTC - Get Report) and Transocean (RIG).

The best performer on the list, ahead 47.39% year to date in market return, is the Cornerstone Total Return Fund (CRF), which moved up from a sell-recommended grade of E+ to a mark of C, which equates with a hold recommendation.

Although the CRF's largest holdings are blue-chip stalwarts Exxon Mobil (XOM), General Electric (GE - Get Report) and Microsoft (MSFT - Get Report), there are reasons why it hasn't been elevated to buy-recommended status. Unlike the fund's impressive year-to-date market performance, its net-asset-value-per-shares return for 2008 to date has been a negative 7.79%. The divergence between its market performance and its NAV return has left it priced at a sky-high premium of 76.8% over its net asset value per share.

A possible reason for the steady advance of CRF's price is that investors might be attracted to the fund's 14.3% yield. But in 2007, 97% of the fund's payouts to shareholders came from its capital. Some observers feel the same is likely happening this year.

Nicholas-Applegate Intl & Prem Str (NAI) B- E+ Sell to Buy Non-US Equity 2.03 -7.98
Cornerstone Total Return Fund (CRF) C E+ Sell to Hold Equity Income 47.39 -15.50
Dow 30 Premium & Dividend Income (DPD) B D+ Sell to Buy Equity Income 8.78 -1.70
Clough Global Equity Fund (GLQ) C+ D- Sell to Hold Global Equity -3.63 8.42
New America High Income Fund (HYB) B+ C Hold to Buy Corp - High Yield -0.04 -4.37
Van Kampen MA Value Muni Inc (VMV) D- C+ Hold to Sell Municipal Single State 3.86 -4.12
Van Kampen Sel Sector Muni (VKL) C+ B+ Buy to Hold Municipal - National 4.88 -6.59
Neuberger Berman CA Inter Muni Fund (NBW) B- A- Buy to Weak Buy Municipal Single State 3.92 -5.40
Eaton Vance Insured PA Muni Bond (EIP) D C Hold to Sell Municipal Single State 7.56 -0.23
Nuveen Insured MA T/F Adv Muni Fd (NGX) D C Hold to Sell Municipal Single State 2.98 2.99
Source: Ratings - Data as of 4/30/2008.
For an explanation of our ratings, click here.
Richard Widows is a senior financial analyst for Ratings. Prior to joining, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.

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