Buying
closed-end funds at a discount to NAV is equivalent to buying a dollar for less
than a dollar. In other words, the discount provides us with a margin of
safety. And with tax-exempt yields above taxable equivalents today, we have an
additional buffer against rising treasury rates. So, outside of crisis,
downside risk is minimal in our view. The upside, however, is quite attractive
with multiple value drivers. First, if we assume that the consensus opinion is
wrong (we do) and rates retrace much of their recent move over the next twelve
months, then municipals should rally 7% or so given the average duration of the
sector. Second, if we assume that the consensus will again feel starved for
yield over the next twelve months (we do), then current discounts to asset
value should also close, representing another 7% of upside, give or take. Last
but not least, if we are wrong on both fronts, we are comfortable sitting tight
and collecting the 7% average yield on these instruments at current prices. And
if a few things move in our direction over the next year, we believe the upside
(7% + 7% + 7%) looks much better than expected returns on most risk assets with
minimal risk of capital impairment.
................
UPDATE: The Turnkey Analyst blog posted a list of closed-end muni funds trading at discounts to NAV,
HERE.
