The first article in this series, which framed our investment objective and introduced the idea of a Term CEF Ladder, can be found here. We then covered Mortgage Bond, Senior Loan, and High-Yield CEFs. A discussion in the comments section of our HY CEF article prompted me to pen a second article on assorted Corporate Bond CEFs, which among other things compared the liquidation strategies of several CEFs with 2018 termination dates. Convertible bond and preferred stock funds were the next topic.

We now arrive at our final individual asset class, municipal bonds. The tax implications of specific funds will be beyond the scope of this article. We will discuss the tax-free nature of municipal bond coupon payments only in very general terms. We will not get into the differences among various types of municipal bonds (General Obligation, Revenue, etc.), other than linking to this good primer from the MSRB (Municipal Securities Rulemaking Board).

Instead, I would like to focus on a few very broad themes that I noticed while doing my background research on the sector. First, the AAA General Obligation municipal bond curve is slightly steeper than the treasury curve. From Baird’s Muni Fortnightly we have these charts – muni curve in blue on first chart, green on second chart:







(Source: Baird Muni Fortnightly, 6/4/18)

As of the time of this writing (6/14/18), the 5/10yr Muni curve has dribbled even a bit wider and is now 48 basis points compared to the 43bps in the chart above.

Conversely, the 5/10yr treasury curve has remained essentially unchanged over the past few weeks, hovering around 13-14 basis points.

Granted, a 48bp slope in the muni curve over 5 years is not huge, but any additional “roll down” we can get should help on a relative basis versus treasuries. Remember, our investment objective is to outperform plain vanilla fixed income products without assuming much additional risk. This somewhat dated article explains a general roll-down strategy. I include it here mainly as something to keep in mind should the municipal curve continue to steepen further versus treasuries. This “roll-down” strategy is obviously not limited to Term CEFs and is probably best captured in a traditional bond ladder.

Second, Blackrock hosted a municipal closed-end fund conference call on May 9, 2018. The replay information is here. A major theme on the call was the impact of rising leverage costs on CEFs. The bottom line is that these costs are difficult and expensive to hedge. Combined with a flattening yield curve and high called-bond activity forcing reinvestment at lower yields, increased leverage costs are expected to continue to pressure municipal CEF distributions. The managers also noted that any curve steepening or spread widening would cause short-term pain but would allow for reinvestment of portfolio funds at more attractive rates.

At around the 12:00 mark of this call, Blackrock cited an interesting statistic: over the past 20+ years, there have been 40 instances where the month-end National Municipal CEF discount has been greater than 7%. In all but two instances, ensuing 1-year market return was positive, with a median return of 15.8%. The managers noted that at the time of the call (May 9th), the national muni CEF discount was approximately 7.5% to NAV. I would note that we have been in the midst of perhaps the greatest bond bull market of all time over the last 20+ years, but I still found this to be an interesting data point.

Another interesting tidbit from the call (approx. 21:00 minute mark) is that Blackrock estimates a 55-65% correlation between municipal fund leverage costs and the federal funds rate. Put another way, if the federal funds rate rises another 50bps, Blackrock estimates that CEF borrowing costs will rise another 30bps from their current level of 1.5% to 2.0%.

The entire call is worth a listen.

Our third broad theme concerns a structural advantage of municipal bond CEFs. In our first article, we discussed the tax advantages afforded to CEF investors by preferred-share leverage. In their pamphlet, Understanding Leverage in Closed-End Funds, Nuveen gives us this graphic:



(Source: Nuveen – .pdf version is here)

On page 5 of the .pdf, Nuveen notes:

… The cost of preferred-share leverage is mainly the dividend rate demanded by preferred shareholders. Historically, CEF preferred share dividend rates are similar to other short- to intermediate-term rates, and may be fixed or floating.

Dividends usually receive the same tax treatment as the fund’s underlying portfolio income, so preferred shares are often used for municipal bond funds…”

The key point here is that preferred-share leverage is usually tax-free for a municipal bond fund. As investors, this is a structural benefit that would otherwise be unavailable – if we tried to buy municipal bonds on margin in our taxable accounts, our margin debt certainly wouldn’t be tax free!

Let’s move on to the individual fund data. As always, funds are listed in alphabetical order by fund ticker.

Sheet #1: Master Term CEF Worksheet:

Term CEF List - 060818

(Sources: CEFConnect, Fidelity, Morningstar, Fund Fact Sheets, Author’s Own Spreadsheet)

Sheet #2: Fundamental Worksheet – National Municipal Bond CEFs Added:

Fundamental Term CEF Worksheet - 060818

(Sources: CEFConnect, Fidelity, Morningstar, Fund Fact Sheets, Author’s Own Spreadsheet)

National Muni Bond Term Fund #1: Blackrock Municipal 2020 (BKK)

Investment Objective: According to the BKK fund page:

BlackRock Municipal 2020 Term Trust’s (NYSE:BKK) (the ‘Trust’) investment objectives are to provide current income exempt from regular federal income tax and to return $15 per Common Share (the initial offering price per Common Share) to holders of Common Shares on or about December 31, 2020. The Trust seeks to achieve its investment objectives by investing, under normal market conditions, at least 80% of its assets in municipal bonds exempt from federal income taxes (except that the interest may be subject to the federal alternative minimum tax). The Trust invests, under normal market conditions, at least 80% of its assets in municipal bonds that are investment grade quality at the time of investment. The Trust may invest directly in such securities or synthetically through the use of derivatives.

No assurance can be given that the Trust’s investment objectives, including its investment objective of returning $15.00 per share, will be achieved.”

Term Date: 12/31/2020

Current Pricing (6/8/18 close):

1 yr Z-Score: 0.0

Current Premium / Discount: -0.59%

Market Return YTD: 2.53%

NAV Return YTD: 0.44%

Distribution Rate (Mkt): 3.12%

Underlying Assets: According to the 3/31/18 fact sheet, effective duration is 2.17yrs.

The fact sheet is secured, so I cannot copy the graphics here. The BKK fund page allows the user to sort by geography, sector, maturity, credit quality, and call exposure.

A few items of note: 83.18% of fund holdings mature within 0-3 yrs. About 10% of the fund is BB-rated or below. The second largest state exposure is Illinois at 13.26%. The fund has a little over 4% exposure to tobacco bonds.

Leverage / Expenses: The fund has been reducing leverage. It showed a small amount of leverage as/of 3/31/18 but shows 0% at 4/30/18.

The gross expense ratio according to the fact sheet is 0.67%.

Manager Commentary: BFK, BKK, BKN, BSD, and BTA share common annual and semi-annual reports. The latest commentary is from October 2017, so I will not list it here.

My Thoughts on BKK:

By reducing leverage and shortening its holdings, BKK appears to be preparing for liquidation. It is currently under-earning its distribution slightly, but a positive UNII balance ($0.417 vs. $0.04 monthly distribution) provides a decent cushion over the near-term. I would expect the distribution to slowly drop over time, but otherwise BKK looks like a stable, short-duration fund.

National Muni Bond Term Fund #2: Blackrock Muni 2018 Term Trust (BPK)

Investment Objective: According to the BPK fund page:

BlackRock Municipal 2018 Term Trust’s (NYSE:BPK) (the ‘Trust’) investment objectives seek to provide current income exempt from regular federal income tax and to return $15 per common share (the initial offering price per common share) to holders of common shares on or about December 31, 2018. The Trust seeks to achieve its investment objectives by investing, under normal market conditions, its assets in municipal bonds exempt from federal income taxes (except that the interest may be subject to the federal alternative minimum tax). The Trust invests at least 80% of its assets in municipal bonds that are investment grade quality at the time of investment.

No assurance can be given that the Trust’s investment objectives, including its investment objective of returning $15.00 per share, will be achieved.”

Term Date: 12/31/2018

Current Pricing (6/8/18 close):

1 yr Z-Score: 0.10

Current Premium / Discount: -0.66%

Market Return YTD: 1.66%

NAV Return YTD: 0.70%

Distribution Rate (Mkt): 0.40%

Underlying Assets: According to the 3/31/18 fact sheet, the fund’s effective duration is only 0.32yrs. 28% of the fund’s holdings are in cash, and only 0.66% of its holdings have a maturity date longer than 3yrs. Only 2.1% of the fund is in BB or NR-rated securities.

Leverage / Expenses: Leverage is 0% according to the fund page. The gross expense ratio is 0.11%, and management fees seem to have been reduced to 0%.

Manager Commentary: BJZ, BLH, and BPK (all very short-duration term trusts) share common annual and semi-annual reports.

My Thoughts on BPK: BPK cut its monthly distribution from $0.022 to $0.005 on 1/12/18. The cut is not surprising given the fund’s extremely short duration. It will be worthwhile to keep an eye on this fund to see exactly how the termination process plays out. It seems likely that BPK will liquidate as originally expected, as the NAV is currently above $15.00 and the fund’s holdings appear to closely mimic its termination date.

National Muni Bond Term Fund #3: Blackrock Municipal 2030 Target Term (BTT)

Investment Objective: According to the BTT fund page:

BlackRock Municipal Target Term Trust’s (NYSE:BTT) (the ‘Trust’) investment objectives are to provide current income exempt from regular federal income tax (but which may be subject to the federal alternative minimum tax in certain circumstances) and to return $25.00 per common share (the initial offering price per share) to holders of common shares on or about December 31, 2030. The Trust seeks to achieve its investment objectives by investing at least 80% of its assets in municipal bonds exempt from federal income taxes (except that the interest may be subject to the federal alternative minimum tax). The Trust invests at least 80% of its assets in municipal bonds that are investment grade quality at the time of investment. The Trust actively manages the maturity of its bonds to seek to have a dollar weighted average effective maturity approximately equal to the Trust’s maturity date. The Trust may invest directly in such securities or synthetically through the use of derivatives.

No assurance can be given that the Trust’s investment objectives, including its investment objective of returning $25.00 per share, will be achieved.”

Term Date: 12/31/2030

Current Pricing (6/8/18 close):

1 yr Z-Score: -0.90

Current Premium / Discount: -9.15%

Market Return YTD: -2.37%

NAV Return YTD: -1.52%

Distribution Rate (Mkt): 4.02%

Underlying Assets: According to the 3/31/18 fact sheet, effective duration is 11.84yrs. Illinois exposure is 8.5%. About 8.5% of the fund is either rated BB or lower or not rated. The fund has 1.9% exposure to tobacco bonds. Health and transportation bonds each comprise about 19% of fund assets.

Leverage / Expenses: Leverage is 37.8%. BTT has leverage in two forms.

1) Tender Option Bond (TOB) Trusts.

2) Preferred Shares.

TOB Trusts are discussed on page 68 of the semi-annual report:

Certain Trusts leverage their assets through the use of “TOB Trust” transactions. The Trusts transfer municipal bonds into a special purpose trust (a “TOB Trust”). A TOB Trust issues two classes of beneficial interests: short-term floating rate interests (“TOB Trust Certificates”), which are sold

to third party investors, and residual inverse floating rate interests (“TOB Residuals”), which are issued to the participating trusts that contributed the municipal bonds to the TOB Trust…

Each Trust’s transfer of the municipal bonds to a TOB Trust is considered a secured borrowing for financial reporting purposes. The cash received by the TOB Trust from the sale of the TOB Trust Certificates, less certain transaction expenses, is paid to a Trust. A Trust typically invests the cash received in additional municipal bonds.”

Page 69 of the same semi-annual report shows the daily weighted average rate of interest and other expenses on TOB Trusts as 1.91%.

BTT has also issued 750mm in preferred shares. According to page 75 of the semi-annual report, the average annualized dividend rate for these shares for the six-month period ending 1/31/18 was 1.66%. The shares are known as Remarketable Variable Rate Muni Term Preferred (RVMTP) Shares. Search “RVMTP” in the annual or semi-annual report for more details.

The gross expense ratio for BTT is 1.49% according to the fact sheet.

Manager Commentary: BBF, BFO, BFZ, BNJ, BNY, and BTT share common annual and semi-annual reports.

Pages 10-11 of the semi-annual report discuss BTT’s performance for the six-month period ending 1/31/18:

U.S. municipal bonds produced generally flat returns during the period, with income offsetting a modest decline in prices. Stronger economic growth and concerns about emerging inflation pressures fueled expectations that the Fed would continue to tighten monetary policy, dampening returns across the fixed-income market.

The Trust’s position in New Jersey bonds made a meaningful contribution to performance. The state government passed legislation that redirected roughly $1 billion annually in lottery proceeds to its pension funds, which helped stabilize its credit rating and contributed to outperformance for the state’s debt.

Positions in the tax-backed and health care sectors made positive contributions to absolute performance.

The Trust’s investments in lower-rated issues, which outpaced the broader market, also aided results.

The Trust’s allocation to zero-coupon bonds, while limited, detracted from performance since their longer duration accentuated the negative price performance in a down market. (Duration is a measure of interest-rate sensitivity.)

Reinvestment had an adverse effect on the Trust’s income, as the proceeds of higher-yielding bonds that matured or were called needed to be reinvested at lower prevailing rates.”

My Thoughts on BTT:

As noted above, Blackrock hosted a municipal closed-end fund conference call on May 9, 2018. One of the topics discussed on the call was reinvestment risk, as the proceeds from called higher-coupon, legacy core positions are being reinvested at lower yields. The managers of BTT mention the same issue in their commentary above. Overall, BTT is a longer fund, but is also one of the larger funds we have looked at, with over 1.6bb in net assets.

National Muni Bond Term Fund #4: Eaton Vance Municipal Income 2028 Term Trust (ETX)

Investment Objective: The ETX fund page is here. According to the 3/31/18 fact sheet:

The Fund’s investment objective is to provide current income exempt from regular federal income tax. The Fund will seek to achieve its investment objective by investing primarily in municipal obligations, a portion of which will be investment grade and a portion of which may be below investment grade at the time of investment.”

It was not easy to find the scheduled termination date for this fund. On page 14 of the annual report, ETX’s termination date is listed as 6/30/2028.

Current Pricing (6/8/18 close):

1 yr Z-Score: -1.10

Current Premium / Discount: -5.37%

Market Return YTD: -5.53%

NAV Return YTD: -1.06%

Distribution Rate (Mkt): 4.43%

Underlying Assets: According to the 3/31/18 fact sheet, leverage adjusted duration is 8.9yrs.





(Source: ETX Fact Sheet, 3/31/18)

Leverage / Expenses: Leverage at 3/31/18 was 37.3% according to the fact sheet, all in the form of Residual Interest Bonds (RIBs). Page 15 of the annual report discusses these securities, which appear similar to the Term Option Bond residuals discussed by Blackrock. It appears that for the year ended 1/31/2018, the average interest rate including fees incurred by the trust was 1.55%.

Total baseline expenses are 1.07% according to the fact sheet.

Manager Commentary: Eaton Vance provides municipal bond commentary specific to its closed-end fund products (EIM, EIV, EVN, EOT and ETX). On page 2, they comment on ETX’s positioning during Q1 2018.

Eaton Vance Municipal Income 2028 Term Trust (the Trust) (NYSE:ETX) underperformed the Barclays 10-Year Municipal Bond Index (the Index) at net asset value for the quarter. The Fund’s relative performance benefitted from an overweight exposure to insured Puerto Rico bonds, an allocation to lower quality municipal bonds and security selection among local general obligation bonds. Lower quality bonds outperformed over the quarter and the local general obligation bonds selected for the Fund outperformed similar bonds in the Index. Detracting from performance was the Fund’s use of TOB leverage, an overweight exposure to zero-coupon bonds, and an overweight exposure to long maturity bonds. The leverage securities act as a financing mechanism allowing investors to borrow at short-term rates and invest in longer-term higher-yielding bonds. Due to the shift in interest rates, the leverage and overweight exposure to longer-term bonds detracted from relative performance.”

From the same report, their investment outlook for the remainder of 2018 notes that credit spreads remain at “historically tight” levels:

In the municipal market, the persistent selling or rebalancing from bank and property & casualty insurance portfolios has somewhat mitigated the technical strength that lower new issue supply typically creates. We believe this dynamic may continue throughout the year. With interest rates materially higher and longer-term muni-to-Treasury ratios cheaper than at the start of the year, we are constructive on investing in today’s environment.

Issuance forecasts for the second quarter of 2018 are light, as many deals were pulled forward on the calendar to the fourth quarter of 2017. This may create a strong technical environment for municipal bonds, as demand remains robust and supply decreases with the loss of advanced refunding bonds.

In addition, the adjustment to the state and local tax deduction law may drive new increased demand for municipal bonds in higher tax states such as California and New York.

Despite ongoing credit challenges for some high-profile issuers, municipal credit is stable overall. With credit spreads at historically tight levels, discipline and seasoned professional oversight are critical in order to safely navigate the waters of the municipal market.

From an overall portfolio perspective, municipals offer tax-free yields with lower risk, given their lack of correlation to other asset classes. With equity markets near all-time highs, municipals may act as a buoy to diversified portfolios if today’s calm markets were to turn stormy and volatile.”

My Thoughts on ETX: ETX has shown quite a bit of volatility this year. As of 3/31/18, the market price was down 7.53% YTD, but has since rebounded a little.

According to page 8 of the annual report, the fund’s highest state exposure is New York at 11.2%, followed by Texas, Arizona and California at around 10% each. Portfolio characteristics could be more detailed, as only the top four states are broken out.

It also sounds like the fund’s use of leverage was a detractor to performance in the first quarter of this year. The fund is overweight longer-term bonds relative to its index. It would be nice to have a more detailed breakdown of fund holdings (maturity, etc.).

Historically, as highlighted in the municipal bond commentary cited above, ETX’s track record against the index is actually pretty solid.

National Muni Bond Term Fund #5: MainStay MacKay DefinedTerm Muni Opp (MMD)

Investment Objective: According to the MMD fund page:

Fund Highlights

An investment-grade municipal bond closed-end fund designed to capitalize on opportunities in the municipal bond market. The Fund offers:

Attractive, generally tax-exempt monthly distributions and total return potential. [1]

1. Distributions may be subject to taxes; please see ‘Tax Risk’ in the ‘Risks’ section for additional information.

An opportunistic investment approach through active management provided by the MacKay Municipal Managers™ team of MacKay Shields LLC, an experienced management team whose strategy seeks to identify relative values across the municipal bond market.

A defined term that seeks to provide the then net asset value (NAV) upon termination to shareholders. Keep in mind the NAV may be more or less than the price paid for shares upon termination. [2]

2. The NAV provided will be as of the Termination Date, not the NAV at the time of the initial public offering.

It is expected that the Fund’s distributions will generally be treated as tax-exempt income for purposes of the regular U.S. Federal income tax. A portion of the Fund’s distributions may be (i) subject to U.S. Federal income tax and such distributions will generally be subject to state and local taxes, and (ii) includable in taxable income for purposes of the Federal alternative minimum tax…”

Term Date: 12/31/2024 according to the annual report.

Current Pricing (6/8/18 close):

1 yr Z-Score: -0.70

Current Premium / Discount: -3.73%

Market Return YTD: 0.03%

NAV Return YTD: 2.03%

Distribution Rate (Mkt): 5.57%

Underlying Assets: According to the 3/31/18 fact sheet, leveraged duration to worst is 6.3yrs, with a weighted final maturity of 18.4yrs.









(Source: MMD Fact Sheet, 3/31/18)

Leverage / Expenses: Leverage is 35.7% according to the fact sheet. The semi-annual and annual reports both describe similar leverage to the funds we have already looked at – a combination of Tender Option Bonds and Preferred Shares.

According to page 20 of the semi-annual report, net expenses excluding interest expense and fees are 1.00%.

Manager Commentary: MMD releases quarterly commentary. Excerpts from Q1 2018 are below – the municipal curve widened as the treasury curve flattened in Q1:

… Municipal market performance in the first quarter of 2018 was heavily influenced by market technicals. Following the unprecedented municipal bond issuance at the end of 2017, new issuance supply in the first quarter declined over 31% year over year with over a 65% drop in refunding issuance following the elimination of tax-exempt financed advanced refundings in the 2017 Tax Cuts and Jobs Act legislation. New tax legislation and high tax rates did result in steady demand and positive flows for the quarter, exceeding the period’s prior year flows by over 100%. As the year began, market expectations of a Federal Reserve Bank interest rate increase encouraged investors to focus on the short end of the curve.

As the quarter ended, this sentiment had eased as the heightened market concerns over disruptive trade policy and equity market reversals have led to a flight to quality in the treasury market, resulting in a flattening of the treasury curve. The municipal market did not follow the treasury market flattening, as the slope of the treasury market curve (as measured by the difference between 2-year and 30-year maturities) flattened by 13 basis points, and the slope of the municipal market curve widened by 33 basis points…

Portfolio Summary

During the quarter MainStay MacKay DefinedTerm Municipal Opportunities Fund (“the Fund”) outperformed its benchmark, the Bloomberg Barclays Municipal Bond Index, which returned -1.11%.

Contributing to performance for the quarter was the Fund’s yield curve position, exposure to high tax states, Virgin Island special tax backed bonds and the Fund’s duration hedging strategy. Yield curve positioning played a positive role in the Fund’s performance during the quarter, as an underweight position to bonds maturing in three to ten years added to performance. Bonds from high tax states, especially California and New York, performed well during the quarter with strong retail demand for bonds. The Fund’s exposure to Virgin Islands securities added to performance, as investor sentiment improved following indications of a strong recovery from the recent hurricanes that occurred in the fall of 2017. The Fund’s hedging strategy also aided performance, mitigating some of the negative pressure from rising rates. Detracting from performance was an overweight exposure to certain Illinois appropriation backed credits, as investors became wary of the outcome of the State’s upcoming budget deadline in June, along with uncertainty associated with the State’s approaching gubernatorial election in November.”

My Thoughts on MMD: The fund has about 30% combined exposure to Puerto Rico and Illinois. Most of the Puerto Rico exposure is insured according to the fund holding pages, so the Illinois exposure may actually be of greater concern. As the fund commentary mentions, Illinois has a budget deadline coming up this June, and it probably makes sense to just watch this fund until we see the results of the budget debate.

MMD has historically been a strong performer within the category of national municipal term funds, but that outperformance may have been achieved by holding weaker, higher-yielding credits during a strong credit cycle. About 25.5% of the fund is either BB-rated or worse, or not rated. It also has a higher distribution yield than the other term funds in this category. MMD has an effective duration that is quite a bit shorter than BTT, and its 2024 term date places it in an attractive section of the curve.

All that said, at this point in the credit cycle I think moving up in quality still makes sense. I will most likely be avoiding this fund due to its relatively weak credit profile.

National Muni Bond Term Fund #6: Western Asset Muni Defined Opp (MTT)

Investment Objective: According to the MTT fund page:

[MTT] Provides a non-leveraged portfolio of investment-grade municipal securities, with a limited term structure that will liquidate on or about April 30, 2021.

Seeks high current income generally exempt from federal income tax with total return as a secondary objective.

Emphasizes team management and extensive credit research expertise to identify attractively priced securities.”

Term Date: 4/30/2021

Current Pricing (6/8/18 close):

1 yr Z-Score: -1.10

Current Premium / Discount: 0.91%

Market Return YTD: 2.33%

NAV Return YTD: 0.06%

Distribution Rate (Mkt): 4.52%

Underlying Assets: Effective duration is 4.5yrs according to the 3/31/18 fact sheet.





(Source: MTT Fact Sheet, 3/31/18)

In scanning through the schedule of investments beginning on page 15 of the annual report, I did not see any outsized state exposure. Illinois holdings were 5.7% of the fund a/o 11/30/17, and the fund does not appear to hold any Puerto Rico paper. Texas looks like the largest state at 12.6%.

Leverage / Expenses: This fund does not employ leverage. Total baseline expenses are 0.70% according to the fund page.

Manager Commentary: The fund manager publishes fund commentary for its municipal closed-end product line. Excerpts are below:

The municipal (“muni”) bond market posted a negative return but outperformed its taxable counterpart during the first quarter.

As was the case with the taxable bond market, munis were dragged down by rising interest rates.

In Western Asset Management’s (“Western’s”) view, municipal balance sheets look better today than they have in the past few years, although fiscal discipline varies from region to region…

Importantly, our investment posture is unchanged since the start of the year. Not only has our positioning worked well thus far, we believe it will continue to perform well during the upcoming months. We continue to favor revenue bonds – especially essential service revenue bonds – over general obligation bonds. The municipal market will evolve in response to changing economic realities, and while investors should expect bouts of elevated spread and rate volatility during the upcoming months, it can be viewed as an opportunity, not an indication of calamity.”

The fund’s semi-annual and annual reports go into further detail on fund holdings.



(Source: MTT Annual Report, 11/30/17)

My Thoughts on MTT: MTT looks like a nice, conservative fund, and it does look like its being managed towards its termination date. The fund holds a large percentage of pre-refunded / escrowed municipals, whose credit risk is essentially equivalent to treasury bonds. A discussion of pre-refunded bonds is here.

In the fund comments, the manager mentions favoring essential service revenue bonds over general obligation bonds. An example of an “essential service” bond would be a water or sewer bond – these bonds support key infrastructure projects and are probably less prone to political risk than other types of municipals. On a combined basis, water & sewer revenue bonds comprise about 11% of the portfolio. Pre-refunded bonds are another 37%, so about half the portfolio is held in very high-quality asset classes.

Another interesting tidbit about MTT is that average portfolio coupon (5.59%) is over 100bps higher than NHA (the other 2021 term fund we will examine). NHA’s average portfolio coupon is 4.51%. On the Blackrock municipal conference call referenced above, Blackrock’s PMs mentioned that legacy higher-coupon positions are the core of their portfolios, and that as those bonds are called, reinvestment risk rises. MTT evidently has a strong core position of higher-coupon bonds, but one has to wonder if they will be able to find enough reinvestment opportunities to maintain such a high distribution relative to other 2020-2021 muni term funds.

One final thing to note about MTT is that due to the lack of leverage, if the manager intends to shorten duration as the fund approaches its 4/30/21 termination date, the fund’s yield could drop rather quickly. Its distribution yield is currently much higher than NHA (the other 2021 term fund we will look at), indicating that its holdings are either longer or riskier on balance.

National Muni Bond Fund #7: Nuveen Municipal 2021 Target Term (NHA)

Investment Objective: According to the NHA fund page:

The Fund seeks to provide a high level of current income exempt from federal income tax and to return the Original $9.85 net asset value per common share on or about March 1, 2021.*

The Fund invests in a portfolio of primarily municipal securities, the income from which is exempt from regular U.S. federal income tax. At least 65% of its managed assets are invested in low- to medium-quality municipal securities that, at the time of investment, are rated BBB/Baa or lower or unrated but judged by the managers to be of comparable quality. The Fund does not invest in securities rated CCC+/Caa1 or lower, or unrated but judged by the managers to be of comparable quality, nor does it invest in defaulted or distressed securities at the time of investment. No more than 25% will be in any one sector, no more than 5% in any one issuer, and no more than 10% in tobacco settlement bonds. Up to 20% may be invested in securities that pay interest that is taxable under the federal alternative minimum tax applicable to individuals (AMT bonds).

The Fund seeks to identify municipal securities across diverse sectors and industries that the managers believe are underrated or undervalued. In seeking to return the original NAV on or about March 1, 2021, the Fund intends to utilize various portfolio and cash flow management techniques, including setting aside a portion of its net investment income, possibly retaining gains and limiting the longest maturity of any holding to no later than September 1, 2021. The Fund uses leverage.

* The objective to return the Fund’s Original NAV is not an express or implied guarantee obligation of the Fund.”

Term Date: 3/1/2021

Current Pricing (6/8/18 close):

1 yr Z-Score: -0.90

Current Premium / Discount: -2.36%

Market Return YTD: 1.53%

NAV Return YTD: 0.88%

Distribution Rate (Mkt): 2.08%

Underlying Assets: Effective duration is 2.24yrs according to the fact sheet.





(Source: NHA Fact Sheet, 3/31/18)

Leverage / Expenses: NHA does not use leverage as of 4/30/18. The fund has used leverage in the past but on March 13, 2018, the fund redeemed its preferred shares with proceeds from the sale of portfolio securities.

Baseline expenses are 0.90% according to the fund page.

Manager Commentary: Nuveen published a fund actions and updates piece for Q1 2018. These general comments give a good idea of the pressures placed on municipal CEFs in the current environment – from page 1:

Distribution Update

The CEF structure tends to result in portfolio turnover rates lower than other fund structures. As a result, portfolio yields tend to be more stable when market yields change. The flattening yield curve and rising borrowing costs have, however, put pressure on fixed-income CEFs over the past year, causing dividend reductions for several Nuveen CEFs in the first quarter.

Municipal CEF earnings faced headwinds as leverage costs continued to rise and proceeds from called bonds were reinvested at rates on the long end of the yield curve. During the quarter, 17 municipal CEFs reduced distributions by 5.0% to 12.3%. The adjustments were primarily the result of increased leverage costs and recent bond call activity…”

NHA is not specifically mentioned in this commentary other than to note a ~ 6% distribution cut. Given that NHA is closer to liquidation than NID or NIQ, the cut for NHA does not seem like too much of a red flag, although it is certainly not a positive.

NHA’s annual and semi-annual reports each contain some commentary on the fund’s strategy. The semi-annual report is more recent (dated 11/30/17) and discusses manager strategy approaching termination. Quoting from the semi-annual report, page 6:

As of the end of the reporting period, NHA’s maturity profile was structured with approximately 63% of the portfolio invested in bonds maturing in 2021, 32% maturing in 2020 and 5% maturing in 2019. As we continue to seek bonds that may be appropriate for the Fund, to the extent possible, we’ll focus on buying 2021 maturities while looking to sell the 2020 maturities first, to continue to reduce the Fund’s interest rate sensitivity as the Fund approaches its term date. In fact, during this reporting period, we were able to increase the Fund’s weighting in 2021 maturities.

The Fund’s credit quality and sector positioning remained in line with Nuveen’s ongoing strategic emphasis on lower rated (including below investment grade) credits and sectors offering higher yields. The Fund’s portfolio turnover was relatively muted in this reporting period as we found opportunities to sell shorter maturity structures and buy bonds maturing in 2021, as well as reinvest the small amount of proceeds from called bonds.”

My Thoughts on NHA: In following Nuveen’s policy of not owning securities with maturities more than six months past the termination date, NHA seems likely to liquidate on schedule in March 2021. The fund has a concentration in lower-rated credits, with about 51% of fund assets BB-rated or lower, or not rated. With a low tax-free distribution yield of just north of 2%, it does not seem like the prospective investor is being compensated for this type of credit risk.

Also note the fund’s small size (83mm in net assets), which is not a positive for trading liquidity.

National Muni Bond Fund #8: Nuveen Intermediate Duration Muni Term (NID)

Investment Objective: According to the NID fund page:

The fund’s primary investment objective is to provide a high level of current income exempt from regular federal income tax. The fund’s secondary investment objective is to seek additional total return.

The fund invests in municipal securities that are exempt from federal income taxes, and seeks to maintain a portfolio with an intermediate effective duration of between 3 and 10 years, including the effects of leverage.

The fund invests at least 50% of its managed assets in municipal securities rated investment grade (Baa/BBB or better by S&P, Moody’s, or Fitch) at the time of investment, or, if they are unrated, are judged by the manager to be of comparable quality. The fund may invest up to 50% of its managed assets in municipal securities rated below investment quality or judged by the manager to be of comparable quality. Up to 20% of its investments may pay interest that is taxable under the federal alternative minimum tax (AMT) applicable to individuals, with an initial target of approximately 5% to 15% of its assets invested in AMT bonds.

The fund uses leverage, and the fund has a 10-year term and intends to liquidate and distribute its then-current net assets to shareholders on or before March 31, 2023.”

Term Date: 3/31/2023

Current Pricing (6/8/18 close):

1 yr Z-Score: -1.30

Current Premium / Discount: -8.08%

Market Return YTD: -1.83%

NAV Return YTD: 0.54%

Distribution Rate (Mkt): 4.08%

Underlying Assets: Leveraged-adjusted effective duration is 7.14yrs, with an effective maturity of 11.66yrs. According to the fund page, top state exposure is Illinois at 15.8%, followed by Florida at 8.9%. NID appears to have limited exposure (less than 1%) to Puerto Rico. Additional info based on the 3/31/18 fact sheet:





(Source: NID Fact Sheet, 3/31/18)

Leverage / Expenses: Effective leverage at 3/31/18 was 36.98% at an average cost of 2.11% according to the fact sheet. On the fund page, the average annualized cost of leverage has increased to 2.50%, highlighting the impact of rising rates on CEF funding costs.

In their leverage grid, Nuveen lists NID as a “High Yield” muni fund, and notes that leverage is in the form of both preferred shares and Tender Option Bonds – this structure is similar to the other muni funds we have looked at.

Baseline expenses on common shares are 0.90% according to the fund page.

Manager Commentary: NID, NHA and NIQ all recently cut their distributions by ~ 6%. As noted above, NHA has been reducing duration and leverage, so the cut may not be a red flag there. However, the story may be different for NID and NIQ.

According to page 1 of their recent fund actions and updates CEF commentary from Q1 2018:

… Municipal CEF earnings faced headwinds as leverage costs continued to rise and proceeds from called bonds were reinvested at rates on the long end of the yield curve. During the quarter, 17 municipal CEFs reduced distributions by 5.0% to 12.3%. The adjustments were primarily the result of increased leverage costs and recent bond call activity.”

For reference, the annual and semi-annual reports for NID both discuss fund strategy, but both are somewhat dated. Please note that NID and NIQ share common reports.

Page 5 of the semi-annual report (11/30/17) gives a feel for how the managers are running both of these funds:

What key strategies were used to manage NID and NIQ during the six-month reporting period ended November 30, 2017?

… As yields on the short end of the yield curve increased more than those on the long end, the yield curve flattened…

In this environment, our trading activity continued to focus on pursuing the Funds’ investment objectives. We continued to seek bonds in areas of the market that we expected to perform well as the economy continued to improve. The Funds’ positioning emphasized intermediate maturities, lower-rated credits and sectors offering higher yields. To fund these purchases, we generally reinvested the proceeds from called and maturing bonds.

Call activity in NID provided ample cash for new purchases during the reporting period. Two sizeable positions, Jefferson County Schools and Temple University Hospital, were called in this reporting period, and we reinvested the proceeds across a diverse range of sectors.

We added to Chicago-related bonds and Illinois general obligation (GO) bonds, which turned out to be among the better performing holdings in this reporting period overall. We also participated in a large new issue that came to market, the American Dream Meadowlands Project, a new mega-mall shopping and entertainment complex currently under construction in New Jersey, which we believed were undervalued by the marketplace and subsequently performed well during the reporting period. NID also bought more Guam bonds, notably a limited obligation issue known as Section 30 Revenue Bonds, which are secured by the income tax revenue collected from U.S. military personnel living on the island. We also took advantage of opportunities to swap some of NID’s tobacco settlement bonds, trading lower coupon structures for higher coupon structures when market conditions were favorable to do so.

NIQ also funded substantially all of its buying during the reporting period with the proceeds from called and maturing bonds. We bought a longer-dated health care credit and a toll road bond, as well as executed a number of smaller buys (known as odd lots).

As of November 30, 2017, both of these Funds continued to use inverse floating rate securities. We employ inverse floaters for a variety of reasons, including duration management, income enhancement and total return enhancement. As part of our duration management strategies, NID also used duration shortening forward interest rate swaps to help maintain the Funds’ ten-year maximum duration mandate. Since long-term interest rates generally declined during the holding period, the swaps had a negligible impact on performance.”

My Thoughts on NID: NID and NIQ seem to be facing pressure from both sides. Their funding costs are increasing, while at the same time call activity in the portfolio has increased, reducing income.

In addition, unlike other Nuveen term funds, NID does not seem to have a maturity mandate regarding its 3/31/2023 termination date. In other words, the managers seem much more focused on pursuing yield than managing to the term date. Their comment about using “duration-shortening forward interest rate swaps to maintain the Funds’ ten-year maximum duration mandate” implies that the fund is overweight longer-duration securities relative to its mandate.

I don’t like the fund’s 15%+ exposure to Illinois, and unless the managers shift their strategy soon, it seems likely that this fund’s assets are going to continue to remain much longer in maturity than the expected termination date. NID is benchmarked to intermediate-term indices and admitted in their semi-annual report that portfolio holdings are longer than the index. Extension seems like a real possibility for NID.

NID trades at sizable discount to NAV, so on a trading basis it can’t be disregarded, but I don’t think it’s an appropriate core holding in our Term CEF Ladder.

National Muni Bond Fund #9: Nuveen Intermediate Duration Quality Muni Term (NIQ)

Investment Objective: According to the NIQ fund page:

The fund’s primary investment objective is to provide current income exempt from regular federal income tax. The fund’s secondary investment objective is to seek additional total return.

The fund invests in municipal securities that are exempt from federal income taxes, and seeks to maintain a portfolio with an intermediate effective duration of between 3 and 10 years, including the effects of leverage.

The fund invests at least 80% of its managed assets in municipal securities rated investment grade (Baa/BBB or better by S&P, Moody’s, or Fitch) at the time of investment, or, if they are unrated, are judged by the manager to be of comparable quality. The fund may invest up to 20% of its managed assets in municipal securities rated below investment quality or judged by the manager to be of comparable quality. Up to 20% of its investments may pay interest that is taxable under the federal alternative minimum tax (AMT) applicable to individuals, with an initial target of approximately 5% to 15% of its assets invested in AMT bonds.

The fund uses leverage. The fund has a 10-year term and intends to liquidate and distribute its then-current net assets to shareholders on or before June 30, 2023.”

Term Date: 6/30/2023

Current Pricing (6/8/18 close):

1 yr Z-Score: -1.70

Current Premium / Discount: -8.79%

Market Return YTD: -1.89%

NAV Return YTD: -0.73%

Distribution Rate (Mkt): 3.18%

Underlying Assets: Leverage-adjusted effective duration is 7.71yrs, with an effective maturity of 9.83yrs. Additional info according to the fact sheet:





(Source: NIQ Fact Sheet, 3/31/18)

Leverage / Expenses: Effective leverage was 36.74% at 3/31/18 with an average cost of 2.10%. Similar to NID, leverage costs have increased and are now 2.49% annualized.

Nuveen’s leverage grid shows that NIQ carries leverage in the form of both preferred shares and Tender Option Bonds (familiar story at this point).

Baseline expenses on common shares are 0.81% according to the fund page.

Manager Commentary: As noted above, NID and NIQ share annual and semi-annual reports. See NID manager commentary above for more details on the recent distribution cuts in both of these funds.

From the semi-annual report comes this section on fund positioning for NID and NIQ during the six-month period ended 11/30/17, as well as a discussion of security selection – gives an idea of manager strategy:

NID’s duration and yield curve positioning produced mixed results in this reporting period. The Fund’s duration profile was longer than that of the benchmark, which detracted from performance. However, the underperformance due to duration was largely offset by NID’s yield curve positioning, where the Fund held a longer average maturity than the benchmark and therefore benefited more from the flattening of the yield curve.

For NIQ, a marginal overweight to the shortest end of the yield curve (zero to two years) was advantageous to performance, but the relative gain was diminished by an underweight to the longer end of the intermediate yield curve, which detracted. Overall, NIQ’s duration and yield curve positioning was a mildly positive contributor to relative performance.

In this reporting period, lower rated credits outperformed high grade (AAA and AA rated) credits. NID’s overweight allocations to BBB rated bonds and non-rated bonds added value, as these rating categories performed better than the market as a whole. In keeping with that trend, our security selection in the non-rated segment was another source of relative gains. NIQ also benefited strongly from an overweight allocation to BBB rated bonds, and a corresponding underweight to AAA rated bonds further boosted performance.

The Funds’ sector allocations were generally favorable during this reporting period. NID’s overweight allocations to the hospitals, tobacco settlement and industrial development revenue (IDR) sectors contributed to outperformance, despite a negative impact from an underweight to the transportation sector. NIQ was also bolstered by an overweight to IDR bonds, but exposure to local GOs detracted.

In addition, as Puerto Rico bonds were among the weakest performing segments in this reporting period, NID’s significant underweight and NIQ’s zero weighting in Puerto Rico paper aided relative performance. Individual credit selection was another positive driver in this reporting period. NID’s selection in the IDR sector, as well as our decision to overweight Chicago GOs and the Chicago Board of Education, added relative gains. In NIQ, our selections in lower quality and longer duration bonds generally outperformed, while holdings in higher grade and/or shorter duration bonds lagged.”

My Thoughts on NIQ: Between NID and NIQ, NIQ is clearly the more conservative fund, with higher credit-quality and a slightly shorter effective duration. NIQ has about 10.8% exposure to Illinois, less than NID’s 15%+.

That said, NIQ is substantially smaller (178mm in net assets vs. NID’s 635mm) and has a distribution yield over 100bps lower.

Not surprisingly, the funds tend to trade very similarly. Out of the two, I prefer NIQ’s more conservative profile.

Summary and Conclusion:

We looked at nine National Municipal Term CEFs. BKK and BPK both look like stable short-term funds. NHA also has good structural protections but has a lower-quality portfolio, lower UNII balance and lower distribution yield than BKK. Out of these shorter funds, I prefer BKK. MTT also looks good with a 2021 term date and no leverage, although I am having a tough time figuring out how they are maintaining a 4.5%+ distribution yield (substantially higher than the other 2020-2021 muni funds we looked at).

I wanted to like MMD, NID and NIQ due to their intermediate 2023-2024 term dates, but each seemed to have its own issues. MMD appears to have a weak credit profile (high Illinois and Puerto Rico exposure) but has been a strong historical performer over the past three and five-year periods. My hunch is that at least some of MMD’s outperformance has been aided by a strong credit cycle which has favored weaker credits. NID also has high Illinois exposure and a portfolio with a longer duration than the benchmark. Of the three, NIQ seems to have the most conservative holdings, but has also shown the weakest historical performance.

BTT and ETX are two longer choices with 10+yr term dates. BTT is much larger at 1.6bb+ in net assets vs. 220mm for ETX. BTT also trades at a much larger discount to NAV. ETX does have a shorter effective duration than BTT, and ETX’s average maturity of 12yrs does track its June 2028 term date fairly closely. Frankly, I don’t think the existence of a term date will have much impact on either fund over the near-term.

This article completes our individual sector analysis. I plan to write a final recap article in the near future to review our findings. If you have found this series useful, please consider clicking the “Follow” button. Thank you as always for reading.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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