Closed-end funds are high-yield assets and as such, there’s an element of interest rate sensitivity. That’s particularly true with closed-end funds focusing on municipal debt.
Some such products reside in the Invesco CEF Income Composite ETF (PCEF). PCEF, which follows the S-Network Composite Closed-End Fund Index, is a high-yield asset as evidenced by a 30-day SEC yield of 9.05%.
Currently, some market observers see near-term vulnerabilities in the municipal bond closed-end fund space, but they also believe that scenario of potential near-term pain could give way to long-term gain. That outlook is relevant to investors evaluating PCEF because some of the exchange traded fund’s 117 holdings are dedicated muni products while others are blended closed-end funds with some exposure to municipal debt.
With the Federal Open Market Committee (FOMC) slated to meet next week, market participants are clamoring for clues the Federal Reserve is close to ending its rate-tightening regime. Should those clues emerge, some PCEF components could benefit, assuming the yield curves works out of its flat state.
That flat curve “sparked distribution reductions across leveraged municipal CEFs and reduced investor demand for municipal CEFs. As a result, municipal CEFs saw increased selling pressure on the secondary market, causing the funds to move from a -1.5% discount at the start of 2022 to a -10.9% discount as of the end of March. For context on this change in premium/discount levels, municipal CEF valuations have been narrower 96% of the time over the last 20 years,” noted BlackRock.
The diversification of asset classes offered by PCEF is proving beneficial at a time when muni closed-end funds have experienced some distribution cuts. After all, income is the primary reason why investors tap closed-end funds in the first place.
PCEF, which delivers monthly income, hasn’t delivered material distribution reductions in recent months. Actually, the payout has ticked higher. Still, investors should be mindful of the tax-equivalent yield offered by closed-end funds, particularly munis, and consider consulting a registered investment advisor on this somewhat complex topic.
“Municipal bonds are exempt from federal taxes and investors can potentially receive additional tax benefits by purchasing state and local tax-exempt bonds issued by states and municipalities in which they reside,” concluded BlackRock. “Municipal CEFs, which typically invest in longer maturity investment grade bonds, are currently offering a median tax equivalent distribution rate of 6.9%, which is higher than the current distribution rate of individual municipal bonds.”
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
