The Pros and Cons of Municipal and Bank Loan Closed End Funds

With steep discounts and sky-high yields, income investors may want to look to municipal and bank loan closed-end funds (CEFs) as an income solution. CEFs in these asset classes offer the potential for higher regular income than other investments, but buyers need to be aware of some risks in the current market.

That’s according to Steve O’Neill, CFA, Portfolio Manager at RiverNorth, an investment management firm that specializes in opportunistic strategies in niche markets where the potential to exploit inefficiencies is greatest.

Steve joined RiverNorth in 2007 and serves as Portfolio Manager. Steve co-manages the firm’s closed-end fund trading strategies and helps to oversee the firm’s closed-end fund investment analysts. Prior to joining RiverNorth, Steve was Assistant Vice President at Bank of America in the Global Investment Bank’s Portfolio Management group where he specialized in the corporate real estate, asset management and structured finance industries.

Steve graduated Magna Cum Laude from Miami University of Ohio with a B.S. in Finance and a minor in Economics. He is a CFA charterholder and member of the CFA Institute and the CFA Society of Chicago.

Here’s O’Neill’s quick take on the pros and cons of investing in these CEFs:

Muni CEFs

Pros:

• High tax-exempt yield, currently about 4%
• Discounts in the range of 12% to 15%.  “It’s rare to see discounts so steep,” O’Neill says. “We are in the 95^th to 99^th percentile of cheapness.”

Cons:

• The cost of leverage has increased, and distribution rates are at risk.
• This uncertainty here explains the wide discounts.

Bank loan CEFs 

Pros:

• Bank loan CEFs are offering a =/- 11% taxable yield
• There is a high distribution rate on this floating rate asset.
• Discounts are 12% to 14%, “and that is at the low end of a multi-year range,” says O’Neill.

Cons:

• The below investment grade portfolio of bank loan CEFs carries more risk in a potential recession.

“Recent selling pressure has caused discounts to widen on most CEFs,” says O’Neill. “As always, investors need to choose their asset class first, and then look to CEFs for relative value.”