Retirement Ready Income Programs

The Tax Free Income Closed End Fund Marketplace

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How could anyone not be interested in Tax Free Yields of roughly 7%? On programs that have been in operation for nearly 20 years? And which are generally paying more now (after five years of historically low interest rates) than they did prior to the "financial crisis"?

If your investment professional is not taking you by the wrist and leading you to these diverse investment opportunities... well you decide.

As far as I can tell, managed Closed End Municipal Bond Funds have been around for roughly 25 years. Over 200 are covered in strenuous detail at cefconnect.com, a free website operated by Nuveen. You can study every detail of every fund as thoroughly as you choose to.

The basic principles are relatively simple. An investment company is established, a fund manager hired, and investment capital raised to fund the creation of a diversified portfolio of municipal securities. The fund's capital structure will include short term borrowing equal to roughly 35% of the investment portfolio's value. The common stock of the investment company is traded on the New York Stock Exchange (and, possibly, other exchanges).

The borrowing is referred to as "leverage", which has an unfortunately distasteful connotation --- as an evil conspiracy, of some kind, which adds "unsuitable" risk to the investment portfolio. It does no such thing, although it may lead to higher volatility, at or around times of general financial stress or when a change in the direction of interest rates is anticipated.

What many financial professionals hate about income CEFs is the ease with which they safely produce multiples of the income produced by high "mark up" individual issues and high commission mutual funds --- this is not difficult to understand.

"Volatility" is another button-term (it means that the prices of investment securities go up and down --- not just up as Wall Street would like y'all to expect) that the media likes to push to excite your fear, or to explain the force of gravity in the markets. Securities and markets, by their very nature, are volatile.

They have become more volatile in recent years because of those AOSVs I mentioned in my recent "Lemmings over the Cliff" article. Artificial Ownership Speculation Vehicles, you call them Index Sector Funds or ETFs, mirror security prices, but they are purchased for reasons that have nothing to do with the fundamentals of the companies involved --- they multiply the movements, and other market bodily functions.

Back to CEF "leverage". All commercial enterprise requires some leverage (i.e. borrowing); the vast majority of individuals (especially home owners) have far more "leverage" in their personal balance sheets than any of the CEFs in this study (yes, that was pure conjecture, but it does drive home the point fairly well).

And unlike personal borrowing or security margin programs, there is no direct "collateral" relationship between the CEF manager's short-term borrowing and the managed portfolio. In fact, CEFs are themselves, acceptable margin collateral --- even the margin gods find them less speculative than some financial professionals want you to believe. But "triple the daily change in the S & P short" ETFs.... yeah, baby! 

Wheels turning? Yes (after you have checked with an accounting professional), if you own a portfolio of tax free CEFs, you can actually use it as an emergency borrowing fund! Think about it, but not if you are one of my clients --- margin loans are not acceptable for individuals except in dire emergencies. If you have a "C" corporation, this can create a little financial magic for you. Call me if you don't understand.

Unlike ordinary Mutual Funds, a fixed number of shares are issued and traded just like any other company's shares. The share owners receive dividends, generally on a monthly basis, equal to the excess of interest received by the fund over the fund's expenses. The fund stock price is a function of supply and demand for the common stock of the investment company; nothing at all to do with the net asset value of the portfolio itself.

Wall Street seems baffled by this simplicity. It insists upon focusing on useless NAV vs. stock price comparisons and refuses to include these clearly "income purpose" securities in the "income" asset allocation bucket of monthly statement pie charts.

Surprisingly, there are slightly more state specific funds than there are better diversified "national" funds. Clearly more speculative from a diversification standpoint in less than mega portfolios, personal accountants myopic focus on tax benefits can get you into diversification trouble. There are 28 separate California bond only CEFs... go figure. 

The distribution rate for the Muni CEF funds ranged from 3.54% to 8.17%; more than half had yields between 6% and 7%; 130 were selling at a discount to net asset value. Based on a 15% sampling, the funds are just under 20 years old, contain nearly 260 individual issues, and have an average distribution rate of 6.86%. The annual bond turnover rate is roughly 20%, and most important of all: they are just volatile enough to allow for productive trading.

None of the 200+ CEFs are making "managed" distributions, and none of the sampled CEFs are returning capital to shareholders.

Income investing becomes simple with CEFs. The income is the same regardless of the market value. When the price goes up, they can be sold in a liquid market. When prices fall, positions can be added to, increasing yield, reducing cost basis, and making the next profit taking moment draw closer on the horizon.

Nothing (almost) has concerned me more throughout my career, than the fact that there are still investors out there:

  • sitting on millions of dollars of very low percentage, taxable Government securities and CDs;
  • with multi-million dollar portfolios containing high percentage positions in California bonds, and other ultra short term, lowest of yields, "churnables";
  • who lament over lower CEF market prices when they are fully capable of taking advantage of the higher yields;
  • who would sell their income safety net to jump into bubbling stock markets at five year market highs.

The fact that they exist is understandable; the fact that I have been unable to educate them is unacceptable.

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NOTE: A totally unscientific study of 204 cefconnect listed Muni CEFs was completed on July 24, 2013. The numbers have not been audited by anyone, and none of the figures have been double or triple checked for accuracy. I can show you the numbers on the scratch paper I used and the sampling spreadsheet I prepared, but I am sure there could be errors found somewhere.


 
Retirement Ready Income Programs
2971 Maritime Forest Drive
Johns Island, SC 29455
Phone (800) 245-0494 • Fax (843) 243-8509
Contact Steve directly for additional information: 800-245-0494
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Please read this disclaimer:
Steve Selengut is registered as an investment adviser representative. His assessments and opinions are purely his own. None of the information presented here should be construed as an endorsement of any business entity; the information is only intended to be educational and thought provoking.

Please join the private article mailing list or Call 800-245-0494 for additional information

Risk Management: Income, 401k, and IRA Programs

Take a free tour of a professional investment managers' private SEP IRA program during ten years surrounding the financial crisis:

CLICK HERE

In developing the investment plan, personal financial goals, objectives, time frames, and future income requirements should all be considered. A first step would be to assure that small portfolios (under $50,000) are at least 50% income focused.

At the $100,000 level, between 30% and 40% income focused is fine, but above age 50, the income focus allocation needs to be no less than 40%... and it could increase in 10% increments every five years.

The "Income Bucket" of the Asset Allocation is itself a portfolio risk minimization tool, and when combined with an "Equity Bucket" that includes only Investment Grade Value Stocks, it becomes a very powerful risk regulator over the life of the portfolio.

Other Risk Minimizers include: "Working Capital Model" based Asset Allocation, fundamental quality based selection criteria, diversification and income production rules, and profit taking guidelines for all securities,

Dealing with changes in the Investment Environment productively involves a market/interest rate/economic cycle appreciation, as has evolved in the Market Cycle Investment Management (MCIM) methodology. Investors must formulate realistic expectations about investment securities--- by class and by type. This will help them deal more effectively with short term events, disruptions and dislocations.

Over the past twenty years, the market has transitioned into a "passive", more products than ever before, environment on the equity side...  while income purpose investing has actually become much easier in the right vehicles. MCIM relies on income closed end funds to power our programs.

To illustrate just how powerful the combination of highest quality equities plus long term closed end funds has been during this time... we have provided an audio PowerPoint that illustrates the development of a Self Directed IRA portfolio from 2004 through 2014.

Throughout the years surrounding the "Financial Crisis", Annual income nearly tripled from $8,400 to $23,400 and Working Capital grew 80% $198,000 to $356,000.

Total income is 6.5% of capital and more than covers the RMD.

https://www.dropbox.com/s/b4i8b5nnq3hafaq/2015-02-24%2011.30%20Income%20Investing_%20The%206_%20Solution.wmv?dl=0

Managing income purpose securities requires price volatility understanding and disciplined income reinvestment protocals. "Total realized return" (emphasis on the realized) and compound earnings growth are the key elements. All forms of income secuities are liquid when dealt with in Closed End Funds. 



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Please read this disclaimer:
Steve Selengut is registered as an investment advisor representative. His assessments and opinions are purely his own and do not represent the views of any other entity. None of his commentary is or should be considered either investment advice or a solicitation of business. Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be or should be construed as an endorsement of any entity or organization. The reader should not assume that any strategies, or investments mentioned are any more than illustrations --- they are never recommendations, and others will most certainly disagree with the thoughts presented in the article.