Three of the Best Steady Eddie Muni Funds

08/13/2019 5:00 am EST

Focus: FUNDS

Michael Foster

Editor, BNK Invest

Municipal bonds are the perfect play for this trade-war obsessed market - they're far more stable than your typical stock and they pay bigger dividends, too, observes closed-end fund expert Michael Foster, editor of CEF Insider.

I'm going to show you how to tap the very best steady Eddie munis for a 4.3% average dividend yield.

Here's something that's often overlooked about muni bonds: their payouts are tax-free to most Americans.

This makes a huge difference: for instance, a 4% tax-free muni-bond yield is the same as a 5.8% taxable yield for a married couple with a household income of $120,000 and filing jointly in California.

Now there is one small "snag" here. When it comes to munis, individual investors often get the scraps — the big institutional players get first dibs, because they're the ones who get the call when municipalities issue a fresh round of bonds.

But we can get around that by outsourcing our muni buys to a pro with a big financial institution behind them. The key is to buy our munis through closed-end funds.

Besides CEF managers' expertise and market clout, these funds tend to trade at a discount to NAV — more on this shortly — so you get your bonds on sale. Closed-end funds (CEFs)also tend to have bigger tax-free yields than other kinds of muni-bond funds.

BlackRock California Municipal Income Trust (BFZ)

BFZ trades at an 11.2% discount to NAV, despite its long-term average discount of 4.6% and its strong, steady performance.

While this fund has the lowest yield of the CEFs I'll show you, at just 3.7%, it's seeing higher income from the bonds in its portfolio, suggesting a dividend hike might be around the corner.

Most importantly, BlackRock, the fund's manager, is the largest and most powerful muni-bond investor in the world, with over $6 trillionin assets under management.

That means, as I said above, they get first pick of the best muni-bond issuances as they are initially offered in the bond markets. This first-mover advantage, plus the fund's outsized discount, sets us up for more upside and gives us some downside "insulation" in the months ahead.

Nuveen Pennsylvania Quality Municipal Income Fund (NQP)

Just like BFZ, NQP has had a strong year, and investors are taking notice. This is par for the course, since NQP has a 7.1% annualized return over the last decade that's on the higher end for muni-bond CEFs. Yet NQP still trades at a 10.9% discount.

This is ridiculous, for a couple reasons. For one, NQP has a strong income stream: 4.3% yields flow to shareholders, and as with BFZ, this dividend stream looks ready to rise, thanks to growing income flowing into the fund from its bonds.

But NQP also has a portfolio of high-quality bonds (it focuses on the highest-rated bonds it can get, hence the "Quality" in the name), which makes it one of the less-volatile and lowest-risk muni-bond CEFs on the market.

Finally, Nuveen is another significant player in the bond market, and NQP is ideally positioned to get the best issuances from Pennsylvania before they're released to the broader market.

BlackRock MuniYield New Jersey Fund (MYJ)

With MYJ, you're getting the best of all worlds: strong management, a great discount and big income. Let's start with the yield: an outsized 4.7% dividend stream that is entirely sustainable, thanks to MYJ's diverse portfolio of New Jersey bonds bought during market panics of years past.

MYJ trades at a respectable 5.1% discount to NAV, and its managers, BlackRock once again, get to choose the best issues from New Jersey's massive and diversified economy, thanks to their big presence in the state and heft in municipal-bond markets. Own MYJ and you can capitalize on that unique market access.

Notice how these funds all focus on a single state. Single-state muni-bond CEFs tend to trade at bigger discounts than multi-state CEFs because many CEF investors, especially the risk-averse muni-bond crowd, worry that financial disaster could be around the corner for any particular state, so its best to stick with multi-state funds.

This makes no sense. Not only has no state in the US ever defaulted, but many that were subject to default rumors a few years ago, such as New Jersey, Illinois and California, are seeing their revenues rise and their muni-bond ratings go up, too.  Contrarians who ignored the worrywarts made out like bandits - and you can do the same with these single-state muni-bond CEFs now.

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