As closed-end municipal bond funds cut their distribution rates, dissatisfied investors looking for tax-free income are exploring alternatives.
Reports say at least 45 closed-end funds, most of them muni funds, which utilize leveraging, have been forced to trim their dividend payouts due to increased borrowing costs and a bump in short-term rates. Not surprisingly, many of these fund investors are looking at other options, including individual munis, which maintain their dividends (i.e. interest rates) throughout the life of the investment.
Advantages of individual muni bonds
The hallmark of individual issues, of course, is confidence: Investors know how much tax-free income they’ll receive and, equally important, they know that when their bonds mature (or are called) their principal will be returned in full.
In recent weeks, gyrations in the financial markets seem to be predicated on pundits’ predictions that the new presidential administration will usher in an era of higher inflation and much higher growth. They attribute to the president-elect a pullback in munis along with a decline in Treasury bond prices.
As we noted recently (Post-Election Outlook for Municipal Bonds), that’s certainly a lot of power to ascribe to an event that has yet to occur.
We think these assumptions are misguided. There is scant evidence that conditions are ripe for a spike in inflation or a long-term jump in Treasury yields. Once again, the pundits have resurrected their favorite prediction that we’re in a “rising interest rate environment.”
In fact, we see many more questions than answers.
Munis in today’s economic climate
Europe’s economy was already ailing when Britain voted last summer to exit the European Union. Last week, Italy’s prime minister resigned following a “no” vote on constitutional reforms designed to more easily implement economic and political changes, fueling more concern over the prospects of Italy’s beleaguered banks and raising questions as to whether Italy might also ultimately break from the EU.
The prospects for robust global growth are further clouded by proposals floated by members of the incoming administration to restrict trade and immigration. According to many reports, abrogating free trade agreements with China and Mexico and slapping huge tariffs on goods from those countries – as the president-elect has promised – would cause global growth to slow. They predict growth will not exceed 2% in 2018 and 2019, which is less than half the rate of growth in the years prior to the worldwide financial crisis.
Muni bonds and avoiding uncertainty
How will this all play out? We can’t be sure, and we’re confident no one else can, either.
We are certain, however, that fund investors hurt by dividend cuts will no doubt appreciate the predictability of individual bonds, their ability to control credit risk and the power to ignore the background noise, such as whether the Fed chooses to act on interest rates or if the incoming administration is able to follow through on its campaign pledges.
What the current uncertainty does present, however, is a ripe opportunity for tax-free bond investors to jump in above the fray and generate a higher, predictable stream of tax-free income.
