Muni CEFs: Enticing Tax-Exempt Income and Diverse Exposure
January 14, 2021
Read Time 6 MIN
With interest rates low and investors hunting for yield, municipal bonds could be attractive options for those seeking income given considerable yields with tax advantages. The S-Network Municipal Bond Closed-End Fund Index (CEFMX) is comprised of closed-end funds from an array of leading fixed income managers, providing diverse exposure to municipal bonds and ensuring a basket of funds that are representative of the space. The index methodology also utilizes a smart beta approach to give investors an opportunity to take advantage of fund discounts to their net asset values (NAV). This piece covers the differentiated design of CEFMX and the advantages of the index’s smart beta approach. CEFMX serves as the underlying index for the VanEck Vectors CEF Municipal Income ETF (XMPT).
Introducing Municipal Bonds and the Closed-End Fund Structure.
Municipal bonds (also commonly known as muni bonds or munis) are debt securities issued by state and local governments to fund day-to-day operations and major projects such as building schools, highways, or sewer systems. There are two primary types of munis, general obligation (GO) bonds and revenue bonds. With GO bonds, governments pay back the bonds out of their general funds or with tax increases, while revenue bonds, in contrast, are repaid using the income generated from the project being financed, such as toll fees or airport revenue. Muni bonds are also unique in their generation of interest income that is tax-exempt at the federal level, which can be advantageous for yield-seeking investors.
Muni bonds can be accessed through a variety of products, but the closed-end fund structure has unique features relative to other options. Closed-end funds (CEFs) are mutual funds with greater portfolio efficiency since they are closed to new contributions and redemptions, meaning funds do not have to hold cash for possible redemptions. The CEF structure also allows for investment in less liquid bonds, which can benefit performance by permitting portfolio managers to invest in munis with more risk but higher returns. CEF managers are also able to actively manage their portfolios and utilize leverage to enhance performance.
CEFMX Provides Diverse Muni Exposure With Limited Turnover.
CEFMX is a composite index designed to capture the municipal bond space by tracking a diverse portfolio of muni CEFs. In order to be included in the index, closed-end funds must fall into one of four muni CEF sectors: Leveraged, Unleveraged, Leveraged High Yield, and Unleveraged High Yield (see chart below). In addition, funds must have total assets of at least $100 million, maintain a management fee below 1.5%, and have average daily turnover1 of more than $500,000 per day for the three months prior to the record date. For existing constituents, buffers on certain screening criteria help limit index turnover, which can be a drag on index performance.
CEFMX differentiates itself from muni funds focused on a single region or style by providing diverse muni exposure that is representative of the space overall. The index portfolio includes 64 CEF constituents from 14 different leading fixed income fund managers such as PIMCO, BlackRock, and BNY Mellon. Fund constituents employ a variety of muni trading and investment strategies that consider factors like yield, valuation, and tax sensitivity. While municipal bond holdings in portfolios can be concentrated in a single state or region, CEFMX provides exposure to most U.S. states. As shown in the chart below, only Illinois makes up more than 10% of the index by weighting, and the bottom 40 states make up 36.7% of the index.
CEFMX Provides Broad Muni Sector Exposure, Though Leveraged Muni CEFs Dominate
CEFMX Provides Diversification Across States
Source: S-Network Global Indexes as of December 31, 2020
Profiling CEFMX and Assessing Performance.
Given different fund objectives and strategies, the CEFs in CEFMX include muni bonds with a wide range of credit ratings, though the index tilts toward higher quality credits. As of December 31, 78.4% of the individual issues included in the closed-end funds in the CEFMX Index are rated investment grade, while 8.6% are high yield and 13.0% are unrated. As shown in the table below, the weighted average leverage for the index is 34.5%, with most of the index’s constituents employing leverage to enhance yield and performance. CEFMX’s weighted average maturity of 18.4 years and effective duration of 9.3 years indicate a relatively high sensitivity to maturity risk and interest rate risk, though the index has had strong performance to match. As of December 31, CEFMX has returned 35.8% on a total-return basis over the last five years compared to 20.1% for the S&P National AMT-Free Municipal Bond Index (SPMUNUST), a muni benchmark (see chart below).
| S-Network Municipal Bond Closed-End Fund Index (CEFMX) Fast Facts | |
| Total Constituents | 64 |
| Number of Unique Fund Managers | 14 |
| Weighting of Top 10 Constituents | 48.4% |
| Investment Grade Weighting | 78.4% |
| Weighted Average Leverage | 34.5% |
| Weighted Average Effective Duration | 9.3 years |
| Weighted Average Maturity | 18.4 years |
Source: S-Network Global Indexes as of December 31, 2020
CEFMX Has Outperformed SPMUNUST Over the Last Five Years
Source: S-Network Global Indexes, Bloomberg as of December 31, 2020
CEFMX Takes Advantage of Closed-End Fund Discounts.
Closed-end funds frequently trade at discounts to their NAV, meaning the share price is lower than the NAV. During periods of volatility, CEFs may initially trade at a wider discount to NAV, but the discount can narrow as market dynamics and pricing stabilize. In this scenario, buying the CEF at a discount would drive a higher yield. CEFMX’s smart beta weighting scheme is designed to exploit CEF discounts to its advantage. CEF constituent weights in the index are based on total net assets and adjusted for each fund’s average discount for the previous 90 days. Funds trading at higher discounts receive a greater weight in the index, while CEFs that trade at average premiums of 20% or more are excluded. As of December 31, CEFMX’s average discount to NAV is 4.0% and rests slightly beneath the historical average of 5.3% given some narrowing recently. However, the chart below shows that the index has historically retained a considerable weighted average discount. Wide discounts are a feature of the index and represent an opportunity for investors hoping to enhance yields.
CEFMX Historical Discounts
December 2005 to December 2020
Historical average represents the average of the data points shown.
Source: S-Network Global Indexes, Bloomberg as of December 31, 2020
CEFMX’s Yield Compares Favorably to Other Fixed Income Sectors.
In addition to broad exposure to muni CEFs, perhaps the most apparent case for CEFMX is yield given the current low-rate environment. As of December 31, CEFMX is yielding 4.4%, which is 220 basis points above SPMUNUST and well above U.S. Treasuries and the Bloomberg Barclays US Aggregate Bond Index (LBUSTRUU). In addition to significant yield, income generated from munis is generally exempt from federal taxes, with further tax benefits on the state and local level possible depending on the issue location and the investor’s residence. These tax benefits are especially advantageous for investors in a high federal tax bracket since muni bond yields are often higher on an after-tax (or tax-equivalent) basis. Investors should consult with a tax advisor for guidance specific to their situation. Combining the benefits of tax-exempt yield, diverse muni exposure, and strong performance, CEFMX has proven a differentiated index offering in the municipal bond closed-end fund space, and these features may be especially attractive in a low interest rate environment.
CEFMX Yield Compares Favorably to Other Fixed Income Categories
Source: S-Network Global Indexes, S&P Dow Jones Indices, Bloomberg as of December 31, 2020
CEFMX serves as the underlying index for the VanEck Vectors CEF Municipal Income ETF (XMPT).
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Disclaimers
1 Turnover is defined as shares traded multiplied by share price.
This Document Is Impersonal and Not a Solicitation. In jurisdictions where Alerian, S-Network Global Indexes, or their affiliates do not have the necessary licenses, this document does not constitute an offering of any security, product, or service. Alerian and S-Network Global Indexes receive compensation in connection with licensing its indices to third parties. All information provided by Alerian and S-Network Global Indexes in this document is impersonal and not customized to the specific needs of any entity, person, or group of persons. Alerian, S-Network Global Indexes, and their affiliates do not endorse, manage, promote, sell, or sponsor any investment fund or other vehicle that is offered by third parties and that seeks to provide an investment return linked to or based on the returns of any Alerian or S-Network Global Indexes index.
No Advisory Relationship. Alerian and S-Network Global Indexes are not investment advisors, and Alerian, S-Network Global Indexes, and their affiliates make no representation regarding the advisability of investing in any investment fund or other vehicle. This document should not be construed to provide advice of any kind, including, but not limited to, tax and legal.
You Must Make Your Own Investment Decision. It is not possible to invest directly in an index. Index performance does not reflect the deduction of any fees or expenses. Past performance is not a guarantee of future returns. You should not make a decision to invest in any investment fund or other vehicle based on the statements set forth in this document, and are advised to make an investment in any investment fund or other vehicle only after carefully evaluating the risks associated with investment in the investment fund, as detailed in the offering memorandum or similar document prepared by or on behalf of the issuer. This document does not contain, and does not purport to contain, the level of detail necessary to give sufficient basis to an investment decision. The addition, removal, or inclusion of a security in any Alerian or S-Network Global Indexes index is not a recommendation to buy, sell, or hold that security, nor is it investment advice.
No Warranties. The accuracy and/or completeness of any Alerian or S-Network Global Indexes index, any data included therein, or any data from which it is based is not guaranteed by Alerian or S-Network Global Indexes, and it shall have no liability for any errors, omissions, or interruptions therein. Alerian and and S-Network Global Indexes make no warranties, express or implied, as to results to be obtained from use of information provided by Alerian and S-Network Global Indexes and used in this service, and Alerian and S-Network Global Indexes expressly disclaim all warranties of suitability with respect thereto.
Limitation of Liability. While Alerian and S-Network Global Indexes believe that the information provided in this document is reliable, Alerian and S-Network Global Indexes shall not be liable for any claims or losses of any nature in connection with the use of the information in this document, including but not limited to, lost profits or punitive or consequential damages, even if Alerian and S-Network Global Indexes have been advised of the possibility of same.
Research May Not Be Current. This document has been prepared solely for informational purposes based on information generally available to the public from sources believed to be reliable. Alerian and S-Network Global Indexes make no representation as to the accuracy or completeness of this document, the content of which may change without notice. Alerian and S-Network Global Indexes expressly disclaim any obligation to update the contents of this document to reflect developments in the energy Master Limited Partnership sector. The methodology involves rebalancings and maintenance of indices that are made periodically throughout the year and may not, therefore, reflect real-time information.
Linked Products. Alerian and S-Network Global Indexes licenses its indexes to third parties for the creation of investment funds or other vehicles. Alerian and S-Network Global Indexes are not responsible for the information on these websites or for anything that they provide.
Policies and Procedures. Analytic services and products provided by Alerian and S-Network Global Indexes are the result of separate activities designed to preserve the independence and objectivity of each analytic process. Alerian and S-Network Global Indexes have established policies and procedures to maintain the confidentiality of material non-public information received during each analytic process. Alerian, S-Network Global Indexes, and their affiliates provide a wide range of services to, or relating to, many organizations, and may receive fees or other economic benefits from these organizations.
Copyright. No Unauthorized Redistribution. Alerian and S-Network Global Indexes © 2021. All rights reserved. This document, in whole or in part, may not be redistributed, reproduced, and/or photocopied without prior written permission.
Alerian
alerian.com
info@alerian.com // 972.957.7700
3625 N. Hall St., Suite 1200, Dallas, TX 75219
S-Network Global Indexes
snetworkglobalindexes.com
info@snetworkinc.com // 646.467.7928
267 Fifth Avenue, Suite 508, New York, NY, 10016
Third-Party Distribution
Alerian and S-Network Global Indexes have agreed to allow VanEck to distribute this report to citizens of the United States or its territories, Australia, and Europe, the Middle East and Asia via email and through its website. VanEck is not acting as an agent or representative of Alerian and S-Network Global Indexes. Alerian and S-Network Global Indexes is not affiliated with VanEck.
VanEck Disclosures
The information herein represents the opinion of the author(s), but not necessarily those of VanEck. The mention of a specific security is not a recommendation to buy, or solicitation to sell such security. Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors cannot invest directly in the Index. Index returns assume that dividends have been reinvested.
The Fund's performance, because it is a fund of funds, is dependent on the performance of the Underlying Funds. The Fund is subject to the risks of the Underlying Funds' investments, and the Fund's shareholders will indirectly bear the expenses of the Underlying Funds. In addition, at times certain segments of the market represented by the Underlying Funds may be out of favor and underperform other segments. The shares of a closed-end fund may trade at a discount or premium to its net asset value ("NAV"). Additionally, the securities of closed-end investment companies in which the Fund will invest may be leveraged. As a result, the Fund may be indirectly exposed to leverage through an investment in such securities. An investment in securities of closed-end investment companies that use leverage may expose the Fund to higher volatility in the market value of such securities and the possibility that the Fund's long-term returns on such securities (and, indirectly, the long-term returns of the Shares) will be diminished. An investment in the Fund may be subject to risks which include, among others, market, municipal securities, high yield securities, credit, interest rate, call, tax, liquidity, leverage, anti-takeover measures, non-diversified, investment restrictions, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversified and concentration risks, all of which may adversely affect the Fund. A portion of the dividends you receive may be subject to the federal alternative minimum tax (AMT). There is no guarantee that Fund's income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus , which contains this and other information, call 800.826.2333 or visit vaneck.com/etfs . Please read the prospectus and summary prospectus carefully before investing.
The S&P 500 Indices is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 202 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.
Related Funds
Disclaimers
1 Turnover is defined as shares traded multiplied by share price.
This Document Is Impersonal and Not a Solicitation. In jurisdictions where Alerian, S-Network Global Indexes, or their affiliates do not have the necessary licenses, this document does not constitute an offering of any security, product, or service. Alerian and S-Network Global Indexes receive compensation in connection with licensing its indices to third parties. All information provided by Alerian and S-Network Global Indexes in this document is impersonal and not customized to the specific needs of any entity, person, or group of persons. Alerian, S-Network Global Indexes, and their affiliates do not endorse, manage, promote, sell, or sponsor any investment fund or other vehicle that is offered by third parties and that seeks to provide an investment return linked to or based on the returns of any Alerian or S-Network Global Indexes index.
No Advisory Relationship. Alerian and S-Network Global Indexes are not investment advisors, and Alerian, S-Network Global Indexes, and their affiliates make no representation regarding the advisability of investing in any investment fund or other vehicle. This document should not be construed to provide advice of any kind, including, but not limited to, tax and legal.
You Must Make Your Own Investment Decision. It is not possible to invest directly in an index. Index performance does not reflect the deduction of any fees or expenses. Past performance is not a guarantee of future returns. You should not make a decision to invest in any investment fund or other vehicle based on the statements set forth in this document, and are advised to make an investment in any investment fund or other vehicle only after carefully evaluating the risks associated with investment in the investment fund, as detailed in the offering memorandum or similar document prepared by or on behalf of the issuer. This document does not contain, and does not purport to contain, the level of detail necessary to give sufficient basis to an investment decision. The addition, removal, or inclusion of a security in any Alerian or S-Network Global Indexes index is not a recommendation to buy, sell, or hold that security, nor is it investment advice.
No Warranties. The accuracy and/or completeness of any Alerian or S-Network Global Indexes index, any data included therein, or any data from which it is based is not guaranteed by Alerian or S-Network Global Indexes, and it shall have no liability for any errors, omissions, or interruptions therein. Alerian and and S-Network Global Indexes make no warranties, express or implied, as to results to be obtained from use of information provided by Alerian and S-Network Global Indexes and used in this service, and Alerian and S-Network Global Indexes expressly disclaim all warranties of suitability with respect thereto.
Limitation of Liability. While Alerian and S-Network Global Indexes believe that the information provided in this document is reliable, Alerian and S-Network Global Indexes shall not be liable for any claims or losses of any nature in connection with the use of the information in this document, including but not limited to, lost profits or punitive or consequential damages, even if Alerian and S-Network Global Indexes have been advised of the possibility of same.
Research May Not Be Current. This document has been prepared solely for informational purposes based on information generally available to the public from sources believed to be reliable. Alerian and S-Network Global Indexes make no representation as to the accuracy or completeness of this document, the content of which may change without notice. Alerian and S-Network Global Indexes expressly disclaim any obligation to update the contents of this document to reflect developments in the energy Master Limited Partnership sector. The methodology involves rebalancings and maintenance of indices that are made periodically throughout the year and may not, therefore, reflect real-time information.
Linked Products. Alerian and S-Network Global Indexes licenses its indexes to third parties for the creation of investment funds or other vehicles. Alerian and S-Network Global Indexes are not responsible for the information on these websites or for anything that they provide.
Policies and Procedures. Analytic services and products provided by Alerian and S-Network Global Indexes are the result of separate activities designed to preserve the independence and objectivity of each analytic process. Alerian and S-Network Global Indexes have established policies and procedures to maintain the confidentiality of material non-public information received during each analytic process. Alerian, S-Network Global Indexes, and their affiliates provide a wide range of services to, or relating to, many organizations, and may receive fees or other economic benefits from these organizations.
Copyright. No Unauthorized Redistribution. Alerian and S-Network Global Indexes © 2021. All rights reserved. This document, in whole or in part, may not be redistributed, reproduced, and/or photocopied without prior written permission.
Alerian
alerian.com
info@alerian.com // 972.957.7700
3625 N. Hall St., Suite 1200, Dallas, TX 75219
S-Network Global Indexes
snetworkglobalindexes.com
info@snetworkinc.com // 646.467.7928
267 Fifth Avenue, Suite 508, New York, NY, 10016
Third-Party Distribution
Alerian and S-Network Global Indexes have agreed to allow VanEck to distribute this report to citizens of the United States or its territories, Australia, and Europe, the Middle East and Asia via email and through its website. VanEck is not acting as an agent or representative of Alerian and S-Network Global Indexes. Alerian and S-Network Global Indexes is not affiliated with VanEck.
VanEck Disclosures
The information herein represents the opinion of the author(s), but not necessarily those of VanEck. The mention of a specific security is not a recommendation to buy, or solicitation to sell such security. Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors cannot invest directly in the Index. Index returns assume that dividends have been reinvested.
The Fund's performance, because it is a fund of funds, is dependent on the performance of the Underlying Funds. The Fund is subject to the risks of the Underlying Funds' investments, and the Fund's shareholders will indirectly bear the expenses of the Underlying Funds. In addition, at times certain segments of the market represented by the Underlying Funds may be out of favor and underperform other segments. The shares of a closed-end fund may trade at a discount or premium to its net asset value ("NAV"). Additionally, the securities of closed-end investment companies in which the Fund will invest may be leveraged. As a result, the Fund may be indirectly exposed to leverage through an investment in such securities. An investment in securities of closed-end investment companies that use leverage may expose the Fund to higher volatility in the market value of such securities and the possibility that the Fund's long-term returns on such securities (and, indirectly, the long-term returns of the Shares) will be diminished. An investment in the Fund may be subject to risks which include, among others, market, municipal securities, high yield securities, credit, interest rate, call, tax, liquidity, leverage, anti-takeover measures, non-diversified, investment restrictions, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversified and concentration risks, all of which may adversely affect the Fund. A portion of the dividends you receive may be subject to the federal alternative minimum tax (AMT). There is no guarantee that Fund's income will be exempt from federal, state or local income taxes, and changes in those tax rates or in alternative minimum tax or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus , which contains this and other information, call 800.826.2333 or visit vaneck.com/etfs . Please read the prospectus and summary prospectus carefully before investing.
The S&P 500 Indices is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 202 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spdji.com. S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.