Tag Archives: etf

The Ins And Outs Of Municipal Closed-End Funds

Given the likely continuation of the record low fixed income yield environment for the foreseeable future, potential periods of heightened, future stock market volatility and attractive current yields versus comparable taxable investments, municipal bonds and municipal bond-oriented investment strategies, including closed-end funds , have been in high demand of late. For example, as you will see from the table below, all U.S. Traded Tax-Free National Muni Bond CEFs are now trading, on average, above their 10 year average premium/discount. This has not been the case in the last two years. Click to enlarge Source: Wells Fargo Advisors/Morningstar as of April 14, 2016 . In addition, with respect to municipal bond-focused mutual funds, U.S. Municipal bond funds recently posted their 28th consecutive week of inflows. Consider the mutual fund flow information for Municipal Bond funds relative to Taxable Bond funds below from the Investment Company Institute’s (ICI) Trends in Mutual Fund Investing report for the first two months of 2016. Mutual Fund Classification February 2016 January 2016 January – February 2016 January – February 2015 Domestic Equity -3,330 -15,480 -18,809 8,376 World Equity 10,820 10,507 21,326 13,599 Hybrid -1,457 -10,639 -12,096 6,057 Taxable Bond -3,980 -9,425 -13,405 19,914 Municipal Bond 4,690 4,269 8,959 7,230 Taxable Money Market 44,925 -10,874 34,051 -45,488 Tax-exempt Money Market -7,642 -9,372 -17,013 -2,039 Total 44,026 -41,013 3,013 7,649 Overall, the strong demand for, and low underlying supply of, municipal bonds have kept prices high and yields relatively low during the first quarter, yet I would anticipate demand remaining high for municipal bond-oriented investment strategies for the balance of 2016. As a result, for those interested in adding, or increasing, allocations to municipal bonds through CEFs to their client portfolios, the following overview of the municipal bond CEFs may prove helpful. At present, there are 176 closed-end funds in the Tax-Free Income category outstanding across 19 different strategies; some national and some state specific, according to CEFConnect.com. Category Strategy # of CEFs Tax-Free Income High Yield 6 Tax-Free Income National 88 Tax-Free Income (State) Arizona 2 Tax-Free Income (State) California 22 Tax-Free Income (State) Connecticut 1 Tax-Free Income (State) Florida 1 Tax-Free Income (State) Georgia 1 Tax-Free Income (State) Maryland 2 Tax-Free Income (State) Massachusetts 4 Tax-Free Income (State) Michigan 4 Tax-Free Income (State) Minnesota 2 Tax-Free Income (State) Missouri 1 Tax-Free Income (State) New Jersey 8 Tax-Free Income (State) New York 21 Tax-Free Income (State) North Carolina 1 Tax-Free Income (State) Ohio 3 Tax-Free Income (State) Pennsylvania 6 Tax-Free Income (State) Texas 1 Tax-Free Income (State) Virginia 2 Since CEFs contain their own unique set or risk considerations, including but not limited to the utilization of leverage, it is critical in my view to employ a comprehensive set of selection criteria beyond just looking for those CEFs that have the highest current yield and/or are trading at the deepest discount relative to their own net asset value (NAV). In this regard, some of the screening criteria that we consider at SmartTrust® when selecting municipal CEFs for our applicable unit investment trust (UIT) strategies include, but is not limited to, the following: · Market Cap & Liquidity – measured by total net assets, in U.S. dollars, and average trading volumes of the CEF. We generally look for CEFs with total net assets of $100mm or greater, while also giving consideration for average trading volume. · Distribution Rate – this is the current distribution rate, or yield, of the CEF and is a measure of the current annualized distribution amount divided by the current price – not the NAV. · Distribution Amount – most current cash distribution amount per share. We are only interested in looking at regular income distributions and disregard returns of principal, special (i.e. non-regular) distributions, short term capital gains and long term capital gains. · Earnings per Share (EPS) – this is the most current amount that the CEF earned per share. We generally exclude those CEFs with negative earnings per share. · Earnings/Distribution Coverage Ratio – this ratio compares current earnings to current monthly distribution amounts where ratios over 100% indicate that the CEF is “over-covered” from an earnings/distribution standpoint and ratios under 100% indicate that the CEF is “under-covered” from an earnings/distribution standpoint. We prefer CEFs that have a high Earnings/Distribution Coverage Ratio. · Undistributed Net Investment Income (UNII) – the life-to-date balance of a fund’s net investment income less distributions of net investment income. UNII appears in shareholder reports as a line item on a fund’s statement of changes in net assets. We consider UNII as a cash buffer or a cash reserve to a CEF portfolio. We typically do not consider CEFs with negative UNII balances. · UNII/Distribution Coverage Ratio – this ratio compares current UNII balances to current monthly distribution amounts to determine how many months of distribution coverage are covered by the CEF’s UNII balance. · Premium / (Discount) -the amount which a closed-end fund market price exceeds (premium) or is less than (discount) the net asset value of that CEF. We contend that a CEF trading at a premium does not necessarily mean it is overvalued and a CEF trading at a discount is not necessarily undervalued. There is nothing written in stone that states that a closed-end fund (CEF) ever has to trade at its net asset value. · 52 Week Average Premium / (Discount) – to help gauge the relative value of the current premium / (discount) of a given CEF, we compare the current to premium / (discount) to the 52 week average premium / (discount). Such comparisons are done not only for the CEF itself but also in relation to their category/strategy. For example, CEFs trading below their 52 week averages represent greater relative value to us than those CEFs trading above their 52 week averages. · Effective Leverage ( and type of leverage employed ) – total economic leverage exposure of the CEF and includes structural leverage, which is calculated using leverage created by a fund’s preferred shares or debt borrowings by the fund, as well as leverage exposure created by the fund’s investment in certain derivative investments (including, but not limited to, reverse repurchase agreements). Leverage is typically represented as a percentage of a fund’s total assets. Given the current record low interest rate environment, many CEF managers are still currently employing some form of leverage to enhance their portfolio yields and take advantage of low relative borrowing costs. For example, approximately 97% of all tax-free income CEFs currently employ some form of leverage. Recognizing that portfolio leverage may increase the volatility of a given CEF and leverage itself can provide less value when short-term rates approach or exceed long-term rates, we pay careful attention to the type and amount of leverage that each CEF strategy employs, especially as we are now within what is likely to be a protracted period of gradually rising interest rates. · Expense Ratio – it is important to be cognizant of the effect that the underlying CEF expense ratios have on the overall portfolio performance of the strategy. · Credit Quality – most CEF sponsors report the credit quality breakdown of the underlying bond holdings within their portfolios at different reporting periods. · Maturity – most CEF sponsors report the maturities of the underlying bond holdings within their portfolios at different reporting periods. · Option Adjusted Duration (OAD) – while all CEF sponsors do not necessarily report the OAD of the underlying bond holdings within their portfolios at different reporting periods, financial software providers, such as Bloomberg, do calculate and provide this interest rate sensitivity based information. · AMT Percentage – most CEF sponsors report the AMT percentages of the underlying bond holdings within their portfolios at different reporting periods. This information may be helpful for portfolios allocations to high new worth clients who are within a higher tax bracket. · % of Portfolio Pre-refunded – most CEF sponsors report the percentage of their portfolios that are pre-refunded related to the underlying bond holdings within their portfolios at different reporting periods. We generally look favorably on pre-refunded bonds. To appreciate our perspective, it is necessary to understand how pre-refunded bonds work. Pre-refunded bonds are issued to fund another callable municipal bond, where the issuer of the municipal bond actually decides to exercise its right to buy its bonds back before the bond’s scheduled maturity date. The proceeds from the issue of the lower yield and/or longer maturing pre-refunding bond will usually be invested in U.S. Treasury bills until the scheduled call date of the original bond issue occurs, thereby reducing the credit risk of the original bond issuance. While no screening criteria can guarantee the success of a selected investment strategy, I believe that the multi-factor approach described above can be helpful in uncovering municipal CEFs that strive to pay high, sustainable levels of tax-free income, and provide for total return potential, over the life of each CEF investment strategy. Disclosure: Hennion & Walsh is the sponsor of SmartTrust® Unit Investment Trusts (UITs). For more information on SmartTrust® UITs, please visit smarttrustuit.com . The overview above is for informational purposes and is not an offer to sell or a solicitation of an offer to buy any SmartTrust® UITs. Investors should consider the Trust’s investment objective, risks, charges and expenses carefully before investing. The prospectus contains this and other information relevant to an investment in the Trust and investors should read the prospectus carefully before they invest. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

NGE: Invest In Nigeria’s Economic Revival

I am going to be a bit provocative and suggest that low oil prices is good for the world especially for the oil producers. When we look across the board at the largest global oil producers from Russia to Saudi Arabia, Iran, Venezuela, Nigeria and Brazil. It becomes clear that abundant oil or high oil prices is neither a blessing nor a benefit to the populace of these nations. These nations have been characterised by mismanagement and corrupt usage of funds and it is only now that we have had an extended season of low oil prices that we are now hearing and seeing serious structural, economic and constitutional reforms to wean these nations from almost complete reliance on oil revenues. Nigeria’s Reforms Out of all these nations, the one that excites me the most is Nigeria for a number of reasons. Firstly, nations like Saudi Arabia, Russia and the South Americans have a number of regional and internal political challenges that I believe will act as a drag on their ability to take decisive measures to reorient their economy. On the other hand, despite the matter of Boko Haram, Nigeria is as a whole politically stable and united under one democratically elected leader and administration. This is important because the oil markets are extremely volatile and wild moves there can wreak havoc on a nation’s balance sheet within a short time and the ability to make fast and decisive decisions are very critical to success in the endeavour to shield and wean a nation from dependence on oil or commodities revenues. This is what the Nigerian President Mr. Buhari has begun to do with the banning of large amounts of imports and restriction of the use of dollars in Nigeria thus making it increasingly expensive to do dollar transactions abroad. While these actions in the short term has caused significant disruptions and distortions like the extortionate prices that dollars is currently being sold on the black market, in the medium and long term, many will agree that these actions are the best for the economy. These actions will benefit the economy for three reasons, it will discourage the importation of substandard and dangerous products that are endangering the health and safety of the local population, it will help to stimulate local production which over time will be instrumental for the diversification of the local economy. Finally, it will help to counteract and counter balance the low prices of oil because as oil is traded in dollars, the fall in oil prices means less dollars to import products and also as the level of imports falls and local production increases, it softens the blow of low oil prices. All of these actions will have the combined effect of increasing the price of the naira itself, stabilize the CBN’s dollar reserve accounts, reduce inflation over time and also interest rates can then be reduced to manageable rates. Further, the net effects of this will also make local naira denominated bonds more attractive over the medium to long term. Secondly, they are very much focused on the matter of corruption and have taken several measures to streamline government accounts and increase transparency into how governmental funds are used. As far as I am aware, these are unprecedented steps even for developed economies. Despite this, the administration has come under significant pressure to change their focus back to Nigeria’s other economic challenges without understanding that by simply curtailing and cutting out corruption, the Nigerian economy will begin to experience more stability and success. Local Equity Markets Growth In light of all of the foregoing, in going back to my original thesis, what really excites me about all of these measures is the effect it will have on the local equity markets. Click to enlarge The chart above compares the Brent Crude Benchmark with the Nigerian Stock Market Index and it is self-evident that the correlation between the price of crude oil and the returns from the NSE were much linked. I am gradually coming around to the realization that oil prices will remain depressed for at least another year for various reasons. Firstly, it is clear that the depressed price of global crude oil is a supply problem and not a demand problem especially in the short and medium term. We know this because crude oil demand increased by 1.5 to 1.8 million barrels per day which is a 5 years high yet the price remained depressed. No one can really price or adequately measure when oil prices will increase or supply will reduce based on two factors, one factor is the ongoing saga of shale oil production in North America where it seems that industry consolidation is taking place. It will take about a year for the dust to settle and only then can we know with any certainty where short and medium term prices will be heading. The second major factor is Iran. They continue to be unpredictable and the market is correctly pricing in significant outputs of crude oil from Iran into the price per barrel. What this means is that things will get worse than better but this will be a positive for a nation like Nigeria particularly considering its current reform trajectory. It is my belief that over the next 12 months, we will see a gradual delinking in the chart above whereby oil prices continue to fall perhaps to 20-25 but at the same time, the NSE begins to gain ground as the constituent companies begin to do better under new economic conditions. This is true because if one looks at the listed companies of the NSE, it becomes clear that most of these companies are well placed to do well as this drive to increase local production, consumption and demand consolidates. The chart above is indicative of this divergence within the markets and we can see Dangote Cement, Flour Mills of Nigeria and Oando which is a leading indigenous oil company. As one can see that while they were all nearly at the same place in May 2015, Oando continues to weaken while the other two are gradually strengthening. These two represent construction, agriculture and food production, three sectors that we should see significant growth within the next 12 months as the national policies begin to take root. This final chart is the Global X Nigeria Index ETF NGE which invests at least 80% of its total assets in the securities of the Underlying Index which is designed to reflect broad based equity market performance in Nigeria. This is an ETF that has hit the bottom and has significant upside potential over the next 12 months. Here we can also see that the growth is tentative but increasingly established. This trend of divergence is one that we are seeing across the board whereby as commodities markets weaken, stock prices appreciate especially when the local economy is supported by government policies. To highlight this point, I have added two South American favorites of mine. In the first one, I compared the Brazilian stock market index to the crude oil prices and in the second, I compared the Argentinean stock market to the feeder cattle prices. Click to enlarge Click to enlarge In conclusion, it is my belief that rather than being a negative, low commodities prices can be a stimulant to help commodities dependent nations diversify their economy and thus creating profitable investment opportunities for investors in local production, manufacturing and services companies. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.