Uncovered Opportunities: Secure 12.5% Dividends Hidden Away (Before Interest Rates Decrease)

Uncovered Opportunities: Secure 12.5% Dividends Hidden Away (Before Interest Rates Decrease)

No two ways about it: This chaotic market environment is causing quite a stir, and it's time for all investors to take notice and respond accordingly.

The possibility of escalating inflation, trade wars, the Federal Reserve's uncertain stance on interest rate cuts, and the question of whether AI can indeed deliver on its promised profits is making investors nervous.

But rather than abandon stocks or the stock-focused closed-end funds (CEFs), this is an optimal moment to fortify our stock holdings with CEFs that offer an additional asset with reliable income, low volatility, and a valuable tax shield, too. I'm talking about municipal bonds.

While they may not be the most thrilling investment, these munis are far from boring, as I'll demonstrate.

The Unsung Heroes of Income Investing: Munis

Traditionally, municipal bonds have been the go-to choice for conservative income seekers. They provide tax-exempt income, low default rates, and a loyal investor base that tends to hang onto their munis for the long haul. This loyal, long-term investor pool further boosts the bonds' stability.

Moreover, municipalities are subject to strict borrowing limits, ensuring they can only borrow what they can truly afford. With these safeguards in place, investing in munis takes on less stress than one might experience with taxable bonds or stocks.

And because munis offer tax-exempt income in many cases, high yields are made even more appealing to investors in higher tax brackets. For example, a 5% yield from a muni bond is equivalent to an 8.3% yield from a taxable bond or stock for those in the highest tax bracket.

Why Invest in Municipal Bonds Through CEFs?

The latest market instability has led to higher municipal bond yields, and the funds featuring these bonds, like the muni-bond CEFs, are eagerly buying more attractive offerings. Currently, interest rates are rising more slowly than previously expected, allowing these funds to scoop up the higher-yielding munis available.

When the Fed eventually lowers rates once again, as predicted later this year, these bonds will likely see price gains. Specifically, intermediate and long-term bonds will prove particularly appealing due to their higher yields compared to freshly issued bonds with lower yields.

Moreover, with 2025 expected to bring lower stock returns than the preceding years, stock investors will increasingly look to munis as an attractive income alternative, further supporting this particular investment sector.

Three High-Yielding, Undervalued Muni Bond CEFs

So, which muni-bond CEFs offer the greatest potential rewards? Let's take a closer look at three of the best for this particular market moment, each offering an impressive 12.5% taxable-equivalent yield:

Invesco Value Municipal Income Trust (IIM): This CEF targets undervalued municipal bonds across the US, mitigating geopolitical risk and applying a 6.7% discount to its net asset value (NAV), allowing us to buy its bonds for just over 93 cents on the dollar. Using reasonable leverage (about 32%), the fund benefits from Invesco's low-interest borrowing costs and boasts a weighted average maturity of 18.8 years, securing steady income streams for nearly two decades.

Invesco Quality Municipal Income Trust (IQI): This muni-bond CEF focuses on higher-rated municipal bonds, carrying a 19.28-year weighted average maturity and boasting similar yields to IIM, benefiting from Invesco's advantageous borrowing costs. At a 31.5% leverage ratio, IQI delivers a balance of income and risk, further reduced by its investment in higher-rated bonds.

DWS Municipal Income Fund (KTF): This stalwart fund delivers strong, long-term performance, having been active since 1988. Boasting an impressive 678% total return, it outperforms the iShares National Muni Bond ETF (MUB) and demonstrates the merits of long-term investment strategies. With a 7.6% yield and a 3.2% discount, KTF offers a compelling risk-versus-reward scenario.

Muni-bond CEFs represent an excellent opportunity to amplify income streams while enjoying low volatility compared to stocks. And with over 100 such options available, investors can remain nimble by capitalizing on the most promising funds as market conditions shift.

Michael Foster is the Lead Research Analyst for contrarianoutlook.com.

Disclosure: none

Enrichment Data:

When investing in municipal bond CEFs, several benefits may help bolster your income, reduce your taxes, and provide you with a more stable portfolio during market volatility:

1. Tax-Free Income: By purchasing municipal bonds, investors can benefit from federal income taxes exemptions on the interest earned. This eliminates a significant portion of tax liability for investors in higher tax brackets, making high yields even more affordable.
2. Lower Volatility: Municipal bonds carry a lower risk profile compared to other bonds or stocks. The credit backing these bonds comes from local governments and public entities, which typically have a more stable and reliable source of income.
3. Diversification: CEFs investing in municipal bonds spread investments across various municipal securities, reducing overall portfolio risk. This diversification results in more stable returns and a smoother investment experience.
4. Active Management: Many municipal bond CEFs employ active management strategies, searching for undervalued opportunities and positions that can yield higher-than-average returns. This active touch offers the potential for superior long-term performance.
5. Leverage: Municipal bond CEFs may utilize leverage to magnify funds' value. However, this approach can significantly increase risk levels, including the chance of amplified losses in unfavorable market conditions.
6. Reliable Monthly Distributions: In addition to offering attractive yields, these CEFs distribute income on a regular basis, providing investors with a steady stream of income. These distributions may also be tax-exempt, further reducing the investor's tax liability.
7. Long-Term Relationships: Offering long-term partnerships with municipal dealers can provide CEFs with an informational advantage, allowing them to access more favorable investment opportunities and deliver more consistent returns.

Investing in municipal bond CEFs can be an excellent option for investors looking to boost their income streams, reduce tax liabilities, and stabilize their portfolios during market volatility. By focusing on the right funds and actively managing your portfolio, you can unlock ample financial benefits and build a more robust investment strategy.

1. Despite the market's chaos, it's crucial for investors to consider fortifying their stock holdings with closed-end funds (CEFs) that offer tax-free income, low volatility, and a valuable tax shield, such as tax-free muni bonds.
2. In a high-yield environment, investors in higher tax brackets can particularly benefit from muni bonds' tax-exempt income, which is often more appealing than the yields on taxable bonds or stocks.
3. The latest market instability has led to higher municipal bond yields, making muni-bond CEFs like tax-free CEFs more attractive, as they eagerly buy more attractive offerings at lower prices.
4. As the Fed lowers interest rates again, predicted later this year, these muni bonds will likely see price gains, particularly in the case of intermediate and long-term bonds with higher yields.
5. With 2025 expected to bring lower stock returns than the previous years, investors will increasingly look to high yield funds and munis as an attractive income alternative, supporting this particular investment sector.
6. To capitalize on these opportunities, investors should consider undervalued muni-bond CEFs, like Invesco Value Municipal Income Trust (IIM) or DWS Municipal Income Fund (KTF), which offer a compelling risk-versus-reward scenario and a steady income stream.

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