Deleveraging Closed End Muni Funds

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Greatness
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Deleveraging Closed End Muni Funds

Post by Greatness »

I've been selling off my Blackrock closed end funds. Partly because of the leverage they hold and the near future rate risk, and partly because of what Carl Icahn had stated to Larry Fink about Blackrock funds in a recent public forum. With that said, I have that money sitting in my Vanguard account. Not sure where I can place it the way the market has been for the past few weeks or so. Any suggestions? I liked the income from the Blackrock Muni's, however, I never touched it. I just reinvested. I was thinking buying some Vanguard Balanced Admiral shares, Vanguard Wellington Shares or Vanguard Wellesley Income Shares. Yes, I am aware they are not munis. However, I already own a Vanguard muni fund. I didn't see the point in adding to it. Open to suggestions, comments and even a little bit of criticism. :|
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grabiner
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Re: Deleveraging Closed End Muni Funds

Post by grabiner »

You should have an asset allocation plan: X% in US stocks, Y% in foreign stocks, Z% in bonds. Unless something changes in your investment needs, X, Y, and Z should not change; when you sell one bond fund, you should replace it with another bond fund.

The replacement doesn't need to be in the same account; you might choose to replace the old muni fund with Total Stock Market in taxable, and move an equal amount from a US stock fund to a bond fund in your IRA.

What you are proposing is replacing a bond fund with a balanced fund holding both bonds and stocks; this would be increasing the risk of your portfolio. If you want to hold one of these three funds without increasing the risk of your portfolio, you need to sell stocks somewhere to buy bonds.

And the three funds you proposed are all best held in an IRA, not a taxable account, so you wouldn't want to make a direct replacement. If you like, say, Wellesley, buy it in your IRA, and adjust the rest of your allocation to keep the same risk level.
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Greatness
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Re: Deleveraging Closed End Muni Funds

Post by Greatness »

These are excess funds, not retirement funds. Part of my taxable investment account. Additional funds outside my traditional investment index funds which are already in VT, BND and VTI.
Tanelorn
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Re: Deleveraging Closed End Muni Funds

Post by Tanelorn »

Your title references deleveraging. Do you have any reason to worry about deleveraging of muni CEFs, or examples of that currently happening? Muni's might have lost 1-2% in NAV this year, but nothing terrible. If you'd asked about MLPs, well, that might be a different and less pleasant story.
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Greatness
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Re: Deleveraging Closed End Muni Funds

Post by Greatness »

Sinced the Blackrock CEFs use leverage, I calculate that when interest rates rise in the next few months, those funds will be hammered. Hence forth, I sold them with my fair gain. In addition, I've owned them since 2008 - 2009, so they've had a nice run.
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Re: Deleveraging Closed End Muni Funds

Post by Tanelorn »

Ah, you just mean you're worried they're more risky in a downturn due to their leverage. It's probably only 1.3x leverage, but certainly you wouldn't want to be long if rate expectations rise or the credit market gets a lot worse.
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Re: Deleveraging Closed End Muni Funds

Post by unclescrooge »

Greatness wrote:Sinced the Blackrock CEFs use leverage, I calculate that when interest rates rise in the next few months, those funds will be hammered. Hence forth, I sold them with my fair gain. In addition, I've owned them since 2008 - 2009, so they've had a nice run.
Considering that many of these CEFs sell at a 10% discount to NAV, don't you think the quarter percent hike has already been baked in?
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Greatness
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Re: Deleveraging Closed End Muni Funds

Post by Greatness »

Possibly, but with all the leverage, you really do not know how bad the downside could be. Rather take my profit and run. Just looking for a less leveraged, possibly safer environment for the excess funds. Already have 5 pre-paid savings accounts, so cannot put it there.
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grabiner
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Re: Deleveraging Closed End Muni Funds

Post by grabiner »

Greatness wrote:Sinced the Blackrock CEFs use leverage, I calculate that when interest rates rise in the next few months, those funds will be hammered. Hence forth, I sold them with my fair gain. In addition, I've owned them since 2008 - 2009, so they've had a nice run.
Leverage essentially represents an additional exposure to the risk. If you have 10% of your portfolio in a 2x leveraged fund, then you actually have 20% of your portfolio in that asset class, and you can account for that in the risk of your portfolio. A 2x leveraged muni fund with a 5-year duration will lose 10% of its value if rates rise 1%.
Greatness wrote:Possibly, but with all the leverage, you really do not know how bad the downside could be. Rather take my profit and run. Just looking for a less leveraged, possibly safer environment for the excess funds. Already have 5 pre-paid savings accounts, so cannot put it there.
A stock fund, or a balanced fund, is not safer than a leveraged fund holding high-quality munis; look at the 2008 performance of the alternative funds you are considering. If you are trying to decrease the risk, replacing a leveraged bond fund with a non-leveraged bond fund is a good move, as it reduces your bond-market risk without increasing your stock-market risk.
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Re: Deleveraging Closed End Muni Funds

Post by bberris »

If you don't want the leverage, sell down to the no leverage point. There's no need to sell all of your muni funds, just enough to get to the leverage you feel comfortable with.

So if your fund has 33 % leverage, you would sell 33 % of the fund. No more leverage!
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Re: Deleveraging Closed End Muni Funds

Post by AviN »

bberris wrote:If you don't want the leverage, sell down to the no leverage point. There's no need to sell all of your muni funds, just enough to get to the leverage you feel comfortable with.

So if your fund has 33 % leverage, you would sell 33 % of the fund. No more leverage!
Since OP is probably paying high expenses for the closed end fund and since bond funds generally do not accumulate much capital gains, OP would probably be much better off selling the entire holding.

Avi
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Re: Deleveraging Closed End Muni Funds

Post by AviN »

Greatness wrote:These are excess funds, not retirement funds. Part of my taxable investment account. Additional funds outside my traditional investment index funds which are already in VT, BND and VTI.
Funds in a taxable account can be allocated toward retirement. And if they are, they should be included in your retirement asset allocation.

If you have another purpose for the money (i.e. emergency fund, down payment on a house, etc.) then you should have an asset allocation for that purpose.

If you haven't figured out an asset allocation, then now seems like a good time.

Avi
madmid
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Re: Deleveraging Closed End Muni Funds

Post by madmid »

Pl explain why on morningstar growth of 10k chart for VWLUX 10yr+ why when you compare any long established muni CEF e.g. LEO the total value is no different - would seem to me that the 30% leverage should give you 30% more (realize losses are also 30% leveraged down!)
So in the longterm is a CEF muni able to deliver growth in excess of a long term muni fund such as VWLUX -
If true then why go though the hassle?
Thanks
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Greatness
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Re: Deleveraging Closed End Muni Funds

Post by Greatness »

Emergency fund is in HSBC and other High-Yield Pre-Paid Savings accounts. I have about eight months of an emergency fund there. Next level is my own personal investments, which is 30/30/30/5/5 (VT, VTI, BND, VWLUX, VHT). This was a different level of savings/investments considered as excess which was basically MHN, MYN, BNY. The last level is what I already sold and looking to reposition. I guess, to play it safer, I can go into VWLUX. However, how bad would the rate rise hurt these funds? It doesn't really make much sense to go into VWSTX, the yield is less than inflation.
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Greatness
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Re: Deleveraging Closed End Muni Funds

Post by Greatness »

madmid wrote:Pl explain why on morningstar growth of 10k chart for VWLUX 10yr+ why when you compare any long established muni CEF e.g. LEO the total value is no different - would seem to me that the 30% leverage should give you 30% more (realize losses are also 30% leveraged down!)
So in the longterm is a CEF muni able to deliver growth in excess of a long term muni fund such as VWLUX -
If true then why go though the hassle?
Thanks
The real thing that kills many CEFs, at least the Blackrock one's, are the fees. An investor within Blackrock's CEFs is paying on average of 2.50% in management and expense fees. I bought it so low, it really didn't matter much, as it's nearly doubled. However, now that the chicken is coming home to roost, it's a good time to exit; stage right from these funds. The performance, in my opinion, is going to get hit even before you calculate the fees. All in all, the performance against VWLUX doesn't seem that great. Especially when you factor in the CEF fees. Oh if I knew then what I know now...
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Re: Deleveraging Closed End Muni Funds

Post by madmid »

I understand buying a -10% discount covers your expense for 4 years if when you sell it =NAV

but bigger question - why is longterm growth similar to cheap muni fund - after all yield is often 6+% after expense vs VWLUX of 2% so just that should ensure a higher accumulation, and yet difference minimal!!
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Greatness
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Re: Deleveraging Closed End Muni Funds

Post by Greatness »

It was sold to me through my old broker as an income producing vehicle. Where as it performed similarly to the Vanguard LTF, it pays a significantly higher dividend. However, when factoring in the fees and the risks, it really is not worth the risk now a days. In a zero interest rate or low interest rate environment, a little hedging is always good. When rates start to ramp up, you never know how fast (or slow) the FED will act. They are usually behind the ball. Then you have to also factor in how this wacky market will react and for how long it would do so.
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grabiner
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Re: Deleveraging Closed End Muni Funds

Post by grabiner »

madmid wrote:Pl explain why on morningstar growth of 10k chart for VWLUX 10yr+ why when you compare any long established muni CEF e.g. LEO the total value is no different - would seem to me that the 30% leverage should give you 30% more (realize losses are also 30% leveraged down!)
Recheck your chart; the leveraged fund is significantly more volatile. In September-October 2008, VWLUX lost 11% in a month, while LEO lost 19%.

It can also happen that a non-leveraged fund is as volatile as a leveraged fund because the non-leveraged fund holds longer-duration bonds. If a 1.5x leveraged fund holds bonds with a 6-year duration, it will lose 9% of its value when rates rise 1%. If an unleveraged fund holds bonds with a 9-year duration, it will also lose 9% if rates on 9-year bonds rise by the same 1%. (Look at the volatility of the unleveraged very-long-term Treasury funds TLT and EDV to get an idea of this effect.)
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Greatness
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Re: Deleveraging Closed End Muni Funds

Post by Greatness »

grabiner wrote:
madmid wrote:Pl explain why on morningstar growth of 10k chart for VWLUX 10yr+ why when you compare any long established muni CEF e.g. LEO the total value is no different - would seem to me that the 30% leverage should give you 30% more (realize losses are also 30% leveraged down!)
Recheck your chart; the leveraged fund is significantly more volatile. In September-October 2008, VWLUX lost 11% in a month, while LEO lost 19%.

It can also happen that a non-leveraged fund is as volatile as a leveraged fund because the non-leveraged fund holds longer-duration bonds. If a 1.5x leveraged fund holds bonds with a 6-year duration, it will lose 9% of its value when rates rise 1%. If an unleveraged fund holds bonds with a 9-year duration, it will also lose 9% if rates on 9-year bonds rise by the same 1%. (Look at the volatility of the unleveraged very-long-term Treasury funds TLT and EDV to get an idea of this effect.)

Then what's the answer to balance or limit a loss when rates rise?
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grabiner
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Re: Deleveraging Closed End Muni Funds

Post by grabiner »

Greatness wrote:
grabiner wrote:
madmid wrote:Pl explain why on morningstar growth of 10k chart for VWLUX 10yr+ why when you compare any long established muni CEF e.g. LEO the total value is no different - would seem to me that the 30% leverage should give you 30% more (realize losses are also 30% leveraged down!)
Recheck your chart; the leveraged fund is significantly more volatile. In September-October 2008, VWLUX lost 11% in a month, while LEO lost 19%.

It can also happen that a non-leveraged fund is as volatile as a leveraged fund because the non-leveraged fund holds longer-duration bonds. If a 1.5x leveraged fund holds bonds with a 6-year duration, it will lose 9% of its value when rates rise 1%. If an unleveraged fund holds bonds with a 9-year duration, it will also lose 9% if rates on 9-year bonds rise by the same 1%. (Look at the volatility of the unleveraged very-long-term Treasury funds TLT and EDV to get an idea of this effect.)

Then what's the answer to balance or limit a loss when rates rise?
The only way to limit your loss, from any type of risk, is to limit your exposure to the risk. If you hold long-term or leveraged bond funds, you will lose more when rates rise, but you are receiving compensation for taking that risk because you get higher yields. (If you aren't getting compensated for the risk, find a lower-cost investment; there is no point in taking a risk by buying higher-yielding bonds and having the fund company eat the entire risk premium.)

You can also offset the risk of bonds by holding bond funds for the duration. If you hold a bond fund with a 9-year duration, and rates rise by 1%, you will lose 9% of the fund value. However, if you continue to hold the fund for 9 years, the 1% higher rates will make up for the 9% loss, and your 9-year return will be the same as if rates didn't change.
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