Value in Muni Closed End Funds

Closed End Funds (CEF) An Example

The recent spike in rates has provided investors with a unique opportunity to invest at levels that have not been seen in a long time. Nowhere has this become more clear than in the  market for Closed End Funds (CEF’s).  Nuveen Arizona Premium Income Muni Fund (NAZ)  has had a negative return of about  –19.0% during the last year as shown in the chart below.  Part of this poor performance is due to the rise in rates we have seen since the end of April.

 

 

However,  more than half of the poor performance is due to a change in investors’ eagerness to get out of bond funds.  The NAV of the fund is currently $13.44, but the fund is trading at a discount to NAV of –11.46% for a price of $11.90 per share.  This is the biggest discount to NAV for this fund since Lehman Bros. filed for bankruptcy on 9/15/2008. The chart below shows the discount or premium to NAV over the last year.

 During the last year the share price of NAZ topped out on 1/29/2013 at $16.65 per share.  Today the shares are priced at $11.99 per share for a decline of -24.38%.  The chart below shows the move in share price for NAZ during the last year.  The price of NAZ recently took out the Meredith Whitney low of  $11.81 set on 1/18/2011, when investors sold shares after Whitney’s call for numerous high profile muni defaults.  

Opportunity For Income Investors

We believe this drop in share price has created a good entry point for income oriented investors.  The chart below shows the shares at current market price have an indicated yield of about 6.41%.  We believe this monthly dividend is relatively secure.  The fund has Undistributed Investment Income (UNII) of $0.1653 per share.  This is because the fund only pays out, on average, about 93.44% of earnings.  The remaining balance is booked as UNII.  The fund currently earns about $0.0598 per share monthly and pays out $0.064 per share.  There is enough UNII to maintain the current dividend for at least 3 more years.  At 6.41%, the Taxable Equivalent Yield (TEY)  for an Arizona investor in the maximum tax bracket is 11.47%. 

 

 

If you account for the 3.8% surtax for Obamacare for couples who are married and have a modified adjusted gross income of at least $250,000, the TEY is 12.3%.

 
Conclusion

The recent rise in rates combined with selling pressure from retail accounts has created an opportunity for income oriented investors to purchase CEF’s at very attractive TEY’s.