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Leveraged muni CEFs
Old 01-31-2008, 01:57 PM   #1
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Leveraged muni CEFs

As I mentioned in another thread, I had been buying muni CEFs. The discount has narrowed considerably since I last bought, so I'm looking for some other options.

The last chunk I bought were unleveraged, but now I like the idea of a leveraged fund. The discounts are bigger, and the cost of the leverage should be dropping.

Do I have this right? The funds borrow short-term in an auction. Over the last year, their average cost was about 3.6%, and the most recent auctions brought that cost down to 2.5%. So, the juice should increase as the spread increases on their long-term holdings, right?

Looking at previous periods when the fed eased, these leveraged funds outperfomed their non-leveraged equivalents by a good margin.

No brainer?
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Old 01-31-2008, 02:06 PM   #2
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Not necessarily a no brainer. Leverage cuts both ways, so you wany to be really comfy with what is in the portfolio. In particular, you have to decide how you feel about insured bonds, or whether to take your chances with lower rated or unrated bonds and depend on the fund manager doing good credit work.

I would also be remiss if I did not point out that if we have another disruption in the money markets like at the end of '07, it could be unpleasant for the leveraged funds.

Having said all that I have started buying a levered bank loan fund, after tossing out the appreciated unlevered muni fund.
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Old 01-31-2008, 02:16 PM   #3
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I've never liked leveraged muni funds. I'd much rather take the lower yield and feel more comfortable with the NAV. Of course, with that said, I'm not a big fan of muni bond funds anyway. It seems that when rates are dropping, your dividend drops. And when rates are rising, your value drops. I guess I've just been burned enough that I'd rather buy the bonds themselves at a discount.
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Old 01-31-2008, 02:26 PM   #4
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If the fund has 30% leverage, and duration is 6 years, can I simply quantify the added leverage risk by thinking in terms of an 8.5 year duration?

I realize the insurance debacle and credit crunch adds a new risk, but that seems to be reflected in the yield. Tax-equivalent yields on these things are around 7%. Pretty amazing for AAA munis, I think.
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Old 01-31-2008, 02:30 PM   #5
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It would depend on the fund. A lot of funds use interest rate derivaties to try to hedge away some of the duration mismatch. Then your juice would come from credit spreads and the term structure of credit spreads rather than a duration mismatch. You'd have to look carefully at the fund's docs/letters to see if they hedge. Credit is really the primary risk, IMO.

Which funds did you have in mind?
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Old 01-31-2008, 02:34 PM   #6
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I've been staring at NIF. Their charter allows the use of options, but I can't tell if they're using them. They sell preferreds at auction for the leverage.

Edit: their annual report indicates NPX is their only fund in this class that used swaps. And NIO was the only fund that showed "portfolio insurance" expenses.
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Old 01-31-2008, 03:26 PM   #7
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Quote:
Originally Posted by brewer12345 View Post
It would depend on the fund. A lot of funds use interest rate derivaties to try to hedge away some of the duration mismatch. Then your juice would come from credit spreads and the term structure of credit spreads rather than a duration mismatch. You'd have to look carefully at the fund's docs/letters to see if they hedge. Credit is really the primary risk, IMO.

Which funds did you have in mind?
Well credit isn't the only risk. An inverted yield curve can kill these funds. Duration is important as well. A wise man once told me long ago to stay away from derivative products.
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Old 01-31-2008, 03:33 PM   #8
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Well credit isn't the only risk. An inverted yield curve can kill these funds. Duration is important as well. A wise man once told me long ago to stay away from derivative products.
Ain't no interest rate risk if you are properly hedged, and these sorts of positions are pretty easy to hedge. Plain vanilla interest rate swaps are extremely widely used and are more liquid than the bond market.
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