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The Perfect Storm

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Imagine that as the curve has flattened in bearish style (rates rising), we are finding many funds no longer able to support their dividends and their NAV dropping simultaneously.

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Be careful with lots of closed-end bond funds and even some closed-end equity funds. Why, you may ask? Well most - not all - muni closed-end funds are issued with financial leverage. In other words, they were issued to take advantage of the 'carry trade' or to 'borrow short, lend long.'

Well, that trade is toast, as many hedge funds are finding out and as we suspect some financial institutions will later on. But why be careful?

Imagine that as the curve has flattened in bearish style (rates rising), we are finding many funds no longer able to support their dividends and their NAV dropping simultaneously. This is not, my fellow Minyans, a pretty combination. It is a tinder box. In addition, discounts to NAV's have stubbornly, like in the case of MVF, narrowed substantially, making them a poor value. Even funds that are unleveraged that my firm favors, like NXR and NXQ, get caught up in the selling storm.

Why mention this now? In bear markets in bonds, my experience tells me that we will see widening discounts to NAV's as the year progresses and then the tax selling begins. And that is where it gets nasty. The IRS allows us to sell one fund for a virtually identical fund and reap the tax loss. Usually, selling begets selling, which produces wider discounts, etc., until we take a short visit at year-end to the dreaded 'vomitorium.' Throw in the fact that munis have drastically outperformed Treasuries along the way in this bear market would allow for NAV's to fall as swaps take place in the underlying assets as well.

You might (I am) calling this the perfect storm. Don't bother trying to short them however. Borrowing the shares is nearly impossible as the shares are mostly in the hands of cash accounts and there is a fear of being 'bought in.'

So, if you are going to need a tax loss, think about selling them now, while discounts are narrow and you also might look to rebuy them in the last part of the year. I have practiced this many times in various asset classes, and trust me, it can be VERY profitable, in my experience.

Lastly, there has been a monstrous amount of issuance as investors bought yieldy instruments, no matter how much risk was involved - does anyone actually read a prospectus anymore? This will add even more to supply.
Positions in NXR and NXQ

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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