Join the Bond Giants with this Closed-End Muni Fund

10/15/2019 5:00 am EST

Focus: BONDS

Michael Foster

Editor, BNK Invest

Here’s a little-known fact about munis: when towns, cities and states issue them, they call a select group of customers first — and these lucky buyers get first crack at the best bonds, leaving everyone else out in the cold, asserts Michael Foster, income expert and editor of Contrarian Outlook.

And no, those priority customers aren’t regular folks like you and me. They’re titans like PIMCO and BlackRock, who invest trillions in muni bonds. The bond giants get preferential treatment when new munis come on the scene.

But this doesn’t mean muni bonds are an elite money-maker we’re shut out of. Far from it! Because if we can’t beat the big guys, we’re going to join them by buying their funds. We’re going to get our muni fix through a special kind of fund called a closed-end fund (CEF).

The 5.1% yield is from the Nuveen Municipal High Income Opportunity Fund (NMZ) happens to be one of the top performers over the long haul. Furthermore, NMZ recently raised its dividend, and more dividend increases are likely to come as the Federal Reserve cuts interest rates.

Why? Because more investors are going to be looking for yield, and as the crowd comes to muni bonds, profits from muni-bond funds will grow.

After a near 20% return in less than a year from a low-volatility investment, you might be wondering if it’s too late to get into muni bonds. But if we zoom out a bit, we can clearly see that this isn’t the case.

Over the last three years, NMZ has earned an annualized 5.2%, which is far below its 10-year average annual return of 7.9%. In other words, NMZ’s real profit potential isn’t yet priced in. That’s because investors have ignored NMZ for a long time, due to the Federal Reserve.

From 2015 to late 2018, the Fed entered a period of rising interest rates, which scared muni-bond investors. The idea was that higher Treasury yields would entice investors away from munis and into Treasuries.

Furthermore, there were rumors during the 2016 election that the tax-free status munis have enjoyed for decades would be scrapped.

That obviously never happened, but the resulting muni selloff resulted in a heavily discounted asset class that has taken years to recover. And now that the Fed is cutting rates, the biggest bear case for munis is gone, causing that recovery to intensify.

That rebound still isn’t over, which is why you can jump into a tax-free yielder like NMZ and expect capital gains as the market realizes just how wonderful these funds’ tax-free income can be. It's still a great time to buy NMZ.

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