2013 will be remembered as the year municipal bonds got crushed.
As talk of Federal Reserve tapering grew, investors became spooked by higher rates. Then, following the Detroit bankruptcy, everyone quickly fled the sector.
But today, Capitol Hill is abuzz regarding a potential bailout for municipal bonds. And the smart money is positioning itself to play this bailout.
In fact, political insiders are sinking their money into one niche investment that could shoot to the moon following a municipal bond bailout. It’s as close to foolproof as it gets, since both the Fed and Capitol Hill have the muni bond market’s back. After all, bond money goes directly to government projects.
The Beauty of Closed-End Funds
The opportunity lies in closed-end funds, which come in two major categories: bonds and equities.
Currently, they’re underappreciated by the news media and overlooked by average investors. Combined with a potential muni bond bailout, the time is ripe for investing in closed-end muni bond funds.
These investments allow you to build a portfolio that would be impossible to assemble on your own, in part because they’re professionally managed. The fund managers can use leverage and options strategies and can even invest in illiquid securities.
To get started, each closed-end fund completes an IPO to raise cash and then invests the money. The shares are then traded on an exchange just like regular stocks. They have a fixed number of shares outstanding.
At first blush, a lot of people confuse closed-end funds with mutual, or “open-ended,” funds. They have many of the same characteristics but also have some dramatic differences.
A mutual fund constantly issues and redeems its shares at net asset value (NAV), which is the total per-share worth of the underlying portfolio on any given day.
Sometimes, exchanging shares can cause problems for the investment managers. When a particular mutual fund is hot, for example, money will rush in. Sometimes this flood of money is more than the managers can put to work, making it difficult to get the same outstanding results that sparked interest in the fund in the first place.
Ultimately, the overall returns suffer.
On the flip side, when a mutual fund experiences setbacks, investors flee and the fund shrinks. Managers are forced to sell securities to redeem shares, and the downward spiral is reinforced.
But these problems don’t exist for closed-end funds.
Their stability allows the fund to invest in interesting opportunities and manage its assets without the fear of being blindsided by redemptions.
Consequently, there’s a large community of closed-end equity funds that focuses on emerging, foreign and underdeveloped markets. Some even issue preferred shares and then borrow against them to leverage the fund’s portfolio. This can enhance yields and capital gains.
How to Invest Like the Political Elite
The key to analyzing a closed-end fund is to realize that it can trade at a discount or a premium to NAV.
When a closed-end fund falls out of favor, you can easily pick up shares at a deep discount to NAV. It’s an excellent opportunity to buy assets cheaply. To find out if you’re getting a good deal, just calculate the discount or premium by comparing the fund’s NAV to the price of its shares.
Right now, some of the biggest discounts are in firms that invest in municipal bonds. And it’s signaling a historic buying opportunity.
Take, for example, the Invesco CA Value Muni Common (VCV). It’s one of many municipal bond closed-end funds now trading at a discount. The share price is $11.41, but you’re actually buying $12.14 in municipal bonds. This works out to a discount of 6% plus a yield of over 6%.
You can buy them today at a discount and with high yields. But the high payout won’t last long. There’s good reason to believe shares are headed higher, which would bring yields back down…
You see, these funds have been hurt by the recent tapering talk, but if the Federal Reserve keeps rates down (and I believe it will), then this closed-end bond fund is sure to move higher in the weeks and months ahead.
To life, liberty, and prosperity,