Tax-Exempt Income at a Discount

12/17/2015 9:00 am EST

Focus: FINANCIALS

Robert Carlson

Editor, Retirement Watch

While the Fed might raise interest rates soon, market rates are still going to be near zero on traditional safe income investments, notes Bob Carlson, editor of Retirement Watch.

Investors still won't be able to earn decent income from them; investors who primarily want income from their portfolios must continue to look elsewhere for that cash flow.

Our Retirement Payback portfolio focuses on a menu of other investments, including preferred stock, closed-end funds, MLPs, and more. Our practice is to buy investments when they are relatively low and sell when their prices seem too high to offer an adequate margin of safety.

This strategy is going to have more volatility than traditional income investing. That's a price to be paid for the higher yield.

In line with the approach, we want to add a closed-end fund to our portfolio. We've been in and out of tax-exempt bonds over the last few years through Eaton Vance Municipal Bond II (EIV).

The fund buys primarily long-term tax-exempt bonds. It has low turnover and focuses primarily on the quality of the bond issuer.

It doesn't own general obligation bonds from the troubled states and localities that make headlines. It uses leverage—which recently was about 39% of the fund's value—to increase yields and returns.

From 2009 through 2012, the fund sold at a premium to net asset value. At times, the premium was substantial, exceeding 20%.

We bought the fund in 2013 after the fund tumbled and was selling at a discount to net asset value of around 8%. We sold when the discount shrunk.

The fund tumbled recently again with other income investments and the discount increased. A couple of months ago, it was at an all time high of over 10%. Now it is still over 8%.

Meanwhile, the fund pays a yield of about 5.9%; remember, most of that yield is tax-exempt. And the distributions are all from income. In the last five years, there haven't been any capital gains or return of capital distribution.

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