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Year in Review: Municipal CEFs

We take a look at 2012's municipal CEF performance, distribution cuts, mergers, and more.

Steven Pikelny, 01/18/2013

2012 was a good year for municipal closed-end fund investors. Low short-term interest rates led to cheap leverage financing, while falling long-term municipal rates and lessening concerns over municipal credit quality led to capital appreciation.

As a result, every single municipal CEF, many of which used leverage, had positive net asset value returns for the year. Things also went well from a share price return perspective, with only one fund logging a negative return (AllianceBernstein NY Municipal Income AYN lost a paltry 0.5%). Looking past the amplified capital appreciation, the shape of the yield curve also partially influenced ubiquitous distribution cuts throughout the sector.

Income-oriented investors should note the importance of understanding these trends for the sake of future distributions. The last two weeks have been devoted to year-end reviews of taxable CEF sectors. With this in mind, let's take a closer look at the performance and major developments of the muni CEF market of 2012.


One main trend sticks out from the performance table above: 2012 paid off for riskier funds. The top 10 absolute performers all had below-average credit ratings, while eight of them had above-average leverage ratios. Similarly, eight of the 10 worst performers had either average or above-average credit ratings, while four had below-average leverage. What's more, the worst performers list is largely populated by funds that focus on intermediate- and short-term securities. Looking at the Sharpe ratios of each list (which adjusts performance for volatility, not other risk factors such as interest-rate sensitivity and credit quality), the best performers were still above-average. However, it's worth noting that four of the funds (Eaton Vance Municipal Income EVN, PIMCO Municipal Income PMF, PIMCO Municipal Income II Common PML, and PIMCO Municipal Income III PMX) had either below-average or only slightly above-average Sharpe ratios.

The other thing that sticks out is that share price returns fell short of the performance of the underlying portfolios. While the average NAV increased 15.3%, the average share price only increased 12.6%. In fact, the sector started off the year at an average 2.2% premium, winding up at a 0.2% discount.

Aside from California having appeared to dominate New York, we see some of the same trends among state funds: Three of the top five state funds had below-average credit ratings and high leverage ratios, while the worst performers were all short- or intermediate-focused funds with mostly average credit ratings and leverage ratios.

Steven Pikelny is a closed-end fund analyst at Morningstar.

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