This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

Kass Katch: Buy Closed-End Munis

"You can't get killed falling off of the curb."

-- Grandma Koufax

On a risk/reward basis, closed-end municipal bond funds provide the possibility of an attractive upside return compared to limited downside risk, within the context of either a short- or intermediate-term time frame.

Below is my rationale:

  • Municipal bond funds, under the pressure of credit quality problems and rising interest rates, now sell at a near-record discount to net asset values (over 10%) and at a near-record pretax equivalent yield relative to taxable bonds (high grade and junk).
  • The above conditions of larger-than-historic discounts to net asset value and fear of higher interest rates provide investors and traders with a margin of safety, which, for me, is integral to forming the foundation of every investment.
  • Here is an example of the asset class's serial underperformance. I have arbitrarily produced the year-to-date price performance of the Invesco Pennsylvania Value Municipal Income Trust (VPV).
  • Municipal bond funds are under intense year-end tax selling pressure (which should soon evaporate), as investors seek to offset large unrealized gains in stocks and other asset classes. Gold and municipal bonds were the big losers in 2013; they are for sale (but for only another two weeks).
  • Municipal bond funds are under extreme selling from redeeming investors. Last week a record $1.8 billion was disintermediated in the asset class. Nearly $50 billion was redeemed in the asset class this year (compared to the prior yearly record of only about $20 billion).
  • The average after-tax return of the group of closed-end municipal bond funds I have recently purchased exceeds 7%; the pretax equivalent return is in excess of 10%. (Note: If you lived in California and purchased Cali munis with 9% returns, the return on a taxable equivalent basis is over 14%!)
  • If interest rates drop (as few expect) and credit quality concerns abate (as few expect), discounts to net asset value will likely close and total 12-month returns for the funds I have purchased could be at least 15% without very much risk.
  • By purchasing these funds investors are getting a superior borrowing rate (on average the funds are about 30% leveraged), getting municipal bond expertise and possessing a diversified portfolio and a liquid investment that could be sold at any time.

The risks to the trade are quite obvious -- namely, more municipal credit quality issues might surface (jeopardizing the dividend payouts), interest rates could surge and outflows could continue.

From my perch, the timing of the trade is now, as last week's price action and huge volume transacted appeared to resemble capitulation. I expect a quick January- February recovery after tax selling abates.

Read Pimco's Bill Gross's recent commentary -- he is personally buying closed-end municipal bond funds. Every major municipal profession I know is doing the same in their personal accounts. There is not enough liquidity for Pimco or any other institution to buy but plenty for us mere mortals.

This week probably represents the perfect timing for this trade or investment (depending on your flavor), as most participants are not in during the Christmas week and most of the tax selling will soon be done.

Today's contrarian purchases are at (or right after) the most severe pressure of tax selling. (Note: In Monday's trading interest rates climbed, but every single closed-end municipal bond fund was up modestly in price. This is exactly what I have been waiting for!)

Purchasers of municipal bonds should be aware that not all municipal bonds are tax-exempt, and not all tax-exempt bonds are exempt from all federal and state taxes. The laws governing the taxability of municipal bond income are complex. At the federal level, they are contained in the IRS Code (Sections 103, 141-150). Each state will have its own laws governing what bonds (if any) are exempt from state taxes.

The best thing to do if you are considering this investment theme is to contact your investment adviser for tax suitability.

Keep in mind that your primary residence indicates which municipal bond fund you should own. If you are a resident of a state with no income tax (Florida, Nevada, Washington, Texas, Alaska, South Dakota or Wyoming), all the interest you receive is tax exempt. Thus, you are free to pick and choose among the best and safest closed-end municipal bond funds because you have no state tax liability as well as a federal tax exemption. I am a Florida resident for tax purposes, so I shop around for the best deals, and a package (see below) provides me with portfolio diversification of risk.

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free


Chart of I:DJI
DOW 17,830.76 -210.79 -1.17%
S&P 500 2,075.81 -19.34 -0.92%
NASDAQ 4,805.2910 -57.85 -1.19%

Our Tweets

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs