Municipal CEF Update: High Yields And Wide Discounts

Core Insights - The municipal closed-end fund (CEF) sector has experienced significant distribution hikes in response to activist pressures, which is expected to tighten discounts and attract investor capital from taxable sectors [4][12][21] - The current environment shows tight municipal credit spreads, with upgrades outpacing downgrades, indicating a positive outlook for municipal bonds [3][7][24] - High nominal and real yields in the municipal bond market suggest strong potential returns, especially in the context of a possible macroeconomic shock [19][20] Group 1: Market Dynamics - Municipal CEFs have undergone substantial distribution changes, with many funds increasing distributions multiple times recently, particularly by managers like Nuveen [4][12][28] - The average current yield for municipal CEFs is around 7-8%, which is competitive with other sectors, especially on a tax-equivalent basis for higher-rate taxpayers [6][23] - The distribution hikes are not driven by increasing net income but are a strategic response to activist pressures in the sector [27][28] Group 2: Credit Market Conditions - Municipal credit spreads remain near historical lows, similar to trends observed across the broader credit market [3][8] - The median year-on-year tax collection growth is reported at +1.5%, with personal income collections at +2%, reflecting a stable fiscal environment [7] - The risk profile for credit assets is asymmetric, with municipal bonds expected to perform better during credit drawdowns due to their higher quality and longer duration [11][20] Group 3: Tactical Considerations - The period between Memorial Day and Election Day historically shows positive returns for municipal bonds, with a median return of 2.3% since 1993 [23] - The combination of high yields and tight discounts is likely to attract new demand from investors who typically do not invest in municipal CEFs [17][21] - Recent portfolio adjustments have been made to include CEFs with raised distributions that trade at wide discounts, indicating a strategic shift towards stronger performers in the sector [18][29]