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An Early Tax-Free Holiday Stocking Stuffer?



We have talked about how we feel municipal bonds are cheap relative to Treasuries in the long end of the curve lately. Besides buying individual bonds, you can buy mutual funds; either open-ended or closed-end funds.

Closed-end funds, because they have a finite share base, trade at discounts and premiums to net asset value, depending upon investor's moods about them at that time. Open-end funds feel the sentiment with redemptions and additional funds. At this time of year, tax selling/swapping sometimes pressures creating short-term buying opportunities for a 'January bounce'.

Some years we look at leveraged funds but not this year. As a result of the flatness of the yield curve, these leveraged funds have lost the 'carry trade'-like everyone else. In addition, many have been cutting dividends and charge high management fees. The only way we would be involved is if their discounts got ridiculously large in order to deal with the risk. Usually, the time to own leveraged funds (or leveraged anything for that matter) is when the curve is steep and the fed is on your side.

Two funds that are non-leveraged, have reasonable fee structures and are trading at historically large discounts to net asset value are Nuveen Select Tax-Free Income Portfolio 3 (NXR) and Nuveen Select Tax-Free Income Portfolio 2 (NXQ). They yield approximately 4.85% after tax, are at the high end of their discount to NAV (8.5% and 8.9% respectively). Duration is only around 6 years so their NAV's don't move as much as the long-term bonds that we have previously mentioned. One drawback is a relative lack of liquidity.

Again, not advice, but I don't see anything wrong with buying $1.00 in bonds for $0.91. In the highest tax bracket that works out to nearly a 7.7% taxable equivalent yield. And you have the additional kicker that when the year-end tax selling pressures wear off, they could bounce as the NAV discounts narrow.

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Positions in NXR and NXQ

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