For many fellow contrarian income seekers, the only prescription for income-and-tax fever is safe, reliable interest payments, combined with a dose of tax write-offs. Which brings us to municipal, or "muni" bonds, observes Brett Owens, editor of Contrarian Outlook.
These tax havens collect income from the funding of projects like toll roads in Denver and a convention center renovation in Chicago. Despite headline fears you may have read about muni defaults through the years, they're actually the safest bonds you can buy other than U.S. Treasuries. Default rates regularly run a lean 0.1% to 0.2%.
Most "high bracket" investors love the idea of tax-free muni bonds. But they aren't sure where to buy them and often end up using exchange traded funds as their vehicles of choice. That's a bad idea. Muni ETFs provide a smooth but unfulfilling ride. They don't use leverage, and when yields are this low, it's better to use some to juice the income. Plus, hire the best muni bond pickers.
We contrarians prefer to buy our munis via CEFs (closed-end funds). They are the underappreciated way to play these tax advantaged vehicles, for three reasons:
1) They are actively managed by pros with a legitimate "edge".
2 Their asset pools are fixed, which means they can (and do) trade at discounts to their net asset values (NAVs).
3) They get access to cheap money, which helps them increase returns with minimal risk.
To be clear, leverage gives muni CEFs higher price volatility than no-leverage ETFs. So, it is up to us, as patient investors, to hold these funds through their ups and downs.
We like Nuveen AMT-Free Muni Credit Fund (NVG) as a way to play munis. Nuveen is the godfather of the sector. Portfolio manager Paul Brennan gets the early phone call on many of the best deals in muni-land.
In addiiton, NVG isn't hamstrung by "low risk" investment grade paper. The fund's mandate lets it buy bonds (up to 55% of the portfolio) that are rated Baa/BBB or lower. Giving Paul some room to run is a good thing because he can find valuable bonds in the muni haystack. The ratings are a blunt instrument; Paul is a fine-tooth comb.
Muni bonds are also nice hedges for an uncertain, elevated stock market. NVG's NAV never really moves over time. Since inception in 2002, it's bounced up and down but here we are 19 years later, and its NAV sits a calm 21% higher, not counting the dividends.
It means that NVG has done exactly what it was supposed to do — pay its dividend and make some extra spare change to boot. Two financial crises have passed and here we are, just ahead of where this fund started nearly two decades ago. That makes this perfect for income investors.
If you're in a higher tax bracket, or you believe stocks are simply too high (or both!), then NVG is a nice place to hang out. It pays 4.7% (up to 7.5% tax advantaged) and trades for less than the sum of its safe bond portfolio.