Sunday, May 11, 2008

High Yield Muni Funds with Steady Payouts - A Tax-Free 6% Plus

Given that the flavor of the month will soon be municipal bonds and associated instruments, I wanted to get ahead of the curve and post a few options for investors who want to partake in a potentially safer way to achieve high yields than banking on a quarterly dividend that may be reduced at any time or a wildly fluctuating share price. There are some especially nice instruments (closed-end funds) that save you the time and effort of individually purchasing the bonds yourself.

What makes municipal bond closed-end funds attractive?
  • The most important aspect in my opinion is the risk-adjusted return at this point. Several prominent investors are citing this time as the most attractive time to be purchasing munis in recent history given the spread over treasuries. One might ask why the high premium per lower than commensurate risk? It's the lack of liquidity in the market. These bonds are highly unlikely to default, they're diverse and the yields are likely to decline in the future once liquidity returns to the market.
  • CDs, money markets and savings yields are all dropping to pathetic levels. Treasuries are now yielding negative when accounting for inflation.
  • The ones I cite here pay dividends monthly, and have done so on a consistent basis for years.
  • The owner pays no federal tax on the dividend payments. Roughly, holding a 6% closed end muni fund is equivalent to holding an 8% high yield stock, but without the same risk and the added benefit of non-correlated returns on the underlying asset value.

I've listed a couple states here to chose from:

BlackRock New Jersey Municipal Bond Trust (BLJ) - yielding 6.04% and has been paying the same, steady yield for over 5 years.

BlackRock California Municipal Income Trust (BFZ) - yielding 6.10% and again, has been paying the same, steady yield for over 5 years.

PIMCO Municipal Income Fund (PMF) - yielding 6.34% and again, has been paying the same, steady yield for over 5 years.

What are the risks?

  • For one, states have been paying their employees to live off the public largess for years and there may come a time when full pensions after 20 years of work is no longer a sustainable model. Conversely, states do not hesitate to raise taxes either; PA and NJ have recently passed sales tax increases and the municipality I live in randomly started a 1% local income tax.

  • The share price could continue to decline and if you're looking to sell, you may do so at a loss. I would envision buying these instruments and holding for years as opposed to trading.

  • Do your own research, of course and perhaps buy more than 1 of these in multiple states if you're investing a significant sum.

If you're interested in higher yielding stocks in diverse industries from commodities to international investment, feel free to visit my recent post on my self-directed IRA holdings.

No comments: