As interest rates rise, assets have begun steadily draining out of municipal bond funds. The best barometer of sinking demand, published by the Investment Company Institute (ICI) weekly, showed a net outflow of $34 billion from muni bond mutual funds from mid-April through mid-August. You can access it here:
In addition to about $540 billion held by long-term municipal bond mutual funds, muni closed-end funds (CEFs) hold more than $80 billion. Some of these CEFs soon may represent the best bargains in a down market – the equivalent of "municipal bonds on sale."
As assets have flowed out of munis, a number of CEFs have moved from selling at premiums to steep discounts to net asset value. According to The Wall Street Journal, the average discount on all muni CEFs recently was 7.31 percent. Earlier in 2013, the average CEF sold at a premium of more than 3 percent.
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Of course, municipal bonds are vulnerable to rising interest rates, so investors may want to be patient before diving into discounted CEFs. However, one interesting observation is that today's CEF discounts are about the same in unleveraged funds as in leveraged funds. Because leveraged funds have more vulnerability to rising rates, advisors may want to focus on a handful of unleveraged CEFs that are currently selling at discounts to NAV. The Wall Street Journal published a list of them.
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