In part 1 of our commentary, we discussed the current Fundamental Gravity of our “Slowing Drag...
An ETF for Quality Munis
02/02/2017 9:00 am EST
Invesco Municipal Trust (VKQ) is a high quality diversified municipal bond fund that uses active management of a leveraged portfolio of municipal bonds to provide income to investors, observes Todd Shaver, editor of Bullmarket.com.
Dividends are paid monthly, and the fund uses approximately 38% leverage. The fund’s management fees are 0.9%, which is low for an actively managed bond fund. The fund is also one of the oldest muni-bond closed-end funds, having been established in the early 1990s.
The fund currently covers its distributions with net investment income, and all dividends are considered qualified distributions. This means they are tax free for many investors.
Despite Invesco Municipal Trust’s generous yield — currently around 6% — the fund does not expose investors to high risk bonds that are prone to bankruptcy. In fact, the majority of the fund’s holdings have an A-rating or better.
With only 7% in bonds rated BB or below, Invesco Municipal is not playing the trick of buying very low quality issues to boost payouts.
Lower yields on municipal bonds in our low interest rate world has caused dividends to fall for years. The most recent dividend cut was in September.
Paradoxically, that makes this Trust a very good buy right now. After its dividend cut, the undistributed net income balance went positive, which means it is now covering payouts with the income it is earning from its holdings.
The fund is extremely well positioned to cover its dividend in the long term, leading us to make a bold prediction: After years of cutting distributions, Invesco Municipal Trust will actually raise its dividend by the end of 2018. That increase might happen in 2017 – the wild card is the Federal Reserve.
Several of its holdings are callable or expiring in the next two years. Indeed, nearly a quarter of its bonds will either be called or redeemed by the end of 2018.
They will be able to reinvest that 25% into new, higher yielding issues, thereby raising net investment income and the yield on its assets. That, in turn, will cause the fund’s dividend to rise. The market is not pricing in this potential.
Invesco Municipal Trust is one of the best quality municipal bond funds, and its potential is underpriced by the market. We recommend buying and holding to enjoy the 6% yield, and we expect its yield to rise to closer to 7% by the end of 2018.
Meanwhile, capital gains potential are extremely likely as the bounce in municipal bonds continues. And of course, you realize that if you are in the 30% tax bracket, that 6% yield is the tax-equivalent yield of 8.6%.
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