Municipal Closed-End Funds: Near Term Pain, Long-Term Gain?

Key takeaways

  • Municipal closed-end funds (“CEFs”) primarily invest in investment grade municipal bonds with longer maturities to maximize tax-exempt income.
  • Duration has had a negative impact on municipal CEF returns for the past 18 months and a flatter yield curve has caused leveraged funds to reduce distributions1
  • Municipal CEF discounts typically widen in periods of market stress, but we believe this time may be different as credit remains on strong footing.
  • Municipal CEFs are now trading at some of their widest discount levels over the past 20 years.

Mixed feelings

Over the past year, the municipal bond market has seen increased volatility stemming from rising interest rates across the yield curve. This volatility has been magnified for Municipal CEFs which primarily invest in long duration bonds and use leverage to maximize tax-exempt income. Following challenged performance in 2022 (down -24.4% on market price), municipal CEFs started the year strong, up 5.9% in January 2023, demonstrating how performance rebounded as interest rates fell and investor demand returned. We then saw a reversal in February 2023 given renewed investor fears of future rate hikes by the Fed. The volatility to start the year has been pronounced, and through March 2023 municipal CEFs are up 2.8% on market price for the year.1