Two Top ETFs to Invest in Muni Bonds

11/21/2018 5:00 am EST

Focus: BONDS

Todd Shaver

Founder and Editor-in-Chief, BullMarket.com

We are reiterating our buy recommendation on two closed-end funds in our portfolio — Invesco Municipal Trust (VKQ), with a yield of 5.7% tax free and Nuveen AMT-Free Municipal Credit Income Fund (NVG), with a yield of 5.8%, notes Todd Shaver, editor of BullMarket.

Invesco Municipal Trust invests in municipal bonds, which are attractive given that they are not taxed like traditional debt and therefore can offer affluent investors outsized real returns.

The muni market has underperformed during 2018, primarily due to the recent tax overhaul which prompted many institutions to sell their muni bonds, as well as concerns over rising interest rates which have prompted a broader selloff of the larger credit market.

Yet as interest rates continue to rise, muni debt becomes ever more attractive. The interest earned on muni bonds is not taxed, as you know.

While that reduced drag is less significant during times of low interest rates, as interest rates rise, there’s more money for the IRS to claim and the relative value of a tax-free alternative rises. As a result, funds like this one offer a nice defensive play against our current climate of rising interest rates.

The beauty of investing in the closed-end fund format here is that you don’t have to purchase the underlying bonds yourself, which takes research and more than a little skill. Instead, you can simply purchase the fund and participate in the upside as the muni-debt market appreciates. And you’ll be collecting the equivalent of an 8.8% pre-tax yield in the meantime.

While the muni market has yet to rebound, it’s only a matter of time. The Fed has signaled its intention to raise rates throughout 2019 and potentially beyond, so it’s only a matter of time before investors flee traditional Treasuries for the safety of muni bonds.

This fund right now is sitting at its all-time low (barring a brief period during the 2008-9 credit crash), so it has nowhere to go but up.

It’s also worth noting that muni bond issuance is down over 20% from 2017 levels. That dwindling supply is acting as a floor for muni bond prices, which will begin to pick up once the traditional bond market starts feeling the pain of rising rates. (Again, it’s only a matter of time.)

Shares have traded in a 25% range over the past five years, so while we do believe the stock is headed upwards from today’s bargain-basement price it’s not appreciation we’re after. We’re here for the safe, durable yield and dependable price floor which limits the downside even in truly apocalyptic scenarios.

Nuveen AMT-Free Municipal Credit Income Fund borrows money at short-term rates to buy longer-term debt, effectively making money on the rate spread in the middle. In the recent past, rising short-term rates have been a drag, narrowing that spread and making it harder for funds like this to make money.

As a result, Nuveen slipped 7% in the January correction and was down another 7% in October thanks to the broader market selloff. The good news is that the company is fundamentally stable with a $2.7 billion market cap and a consistent dividend.

Leverage is low and this is one of only a handful of closed-end funds that has been able to avoid reducing its dividend in the past year. We see the dip as a buying opportunity with Nuveen now at a four-year low and the equivalent of 14X earnings.

You’ve probably heard the saying, “A rising tide lifts all boats.” Well, the opposite is also true: “A declining tide lowers even the best boats.” The broader market selloff is temporary, however, which means this fund will see a bounce in the coming months. Now is the time to hop aboard.

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