3 “No Drama” Muni-Bond CEFs To Buy Now (And 1 To Avoid)

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Municipal bonds are the perfect play for this trade-war obsessed market—they’re far more stable than your typical stock and they pay bigger dividends, too.

And today I’m going to show you how to tap the very best “munis” for a 4.3% average dividend yield.

That’s just the start.

One of the three “steady Eddie” buys I’ll show you below even pays an outsized 4.7% dividend. Plus, it trades at a discount to its “true” value, adding to its already legendary stability and setting us up for some nice gains, too.

Turning a 4% Yield Into 5.8%

Here’s something that’s often overlooked about muni bonds: their payouts are tax-free to most Americans.

This makes a huge difference: for instance, a 4% tax-free muni-bond yield is the same as a 5.8% taxable yield for a married couple with a household income of $120,000 and filing jointly in California.

Now there is one small “snag” here. When it comes to munis, individual investors like you and me often get the scraps—the big institutional players get first dibs, because they’re the ones who get the call when municipalities issue a fresh round of bonds.

But we can get around that by outsourcing our muni buys to a pro with a big financial institution behind them. The key is to buy our munis through closed-end funds (CEFs) like the three I’ll reveal shortly.

Besides CEF managers’ expertise and market clout, we get two other big benefits:

  1. More upside: CEFs tend to trade at a discount to NAV—more on this shortly—so you get your bonds on sale.
  2. Bigger yields: CEFs tend to have bigger tax-free yields than other kinds of muni-bond funds. While the iShares National Municipal Bond ETF (MUB) pays out a paltry 2.4% dividend, many muni-bond CEFs pay a lot more, like that 4.3% I mentioned earlier (before the tax benefit), and some pay upwards of 6%.

But how do we pick the right muni-bond funds? Because munis are known for stability, one mistake investors often make is to simply pick the fund with the biggest yield.

You might, for example, be attracted to the PIMCO CA Municipal Income Fund (PCQ) because of its 4.7% yield and annualized 12.2% return over the last decade. But PCQ also trades at a nosebleed 38.3% premium to NAV.

With a run like that and its big premium, PCQ is clearly overvalued.

So you and I are going to go further and find the real bargains in the big world of muni-bond CEFs. Let’s do that now, with three underpriced high-yielding muni-bond funds that give us tax-free dividends and portfolio stability.

Muni-Bond CEF Pick #1: BlackRock California Municipal Income Trust (BFZ)

BFZ trades at an 11.2% discount to NAV, despite its long-term average discount of 4.6% and its strong, steady performance.

While this fund has the lowest yield of the CEFs I’ll show you, at just 3.7%, it’s seeing higher income from the bonds in its portfolio, suggesting a dividend hike might be around the corner.

Most importantly, BlackRock, the fund’s manager, is the largest and most powerful muni-bond investor in the world, with over $6 trillion in assets under management.

That means, as I said above, they get first pick of the best muni-bond issuances as they are initially offered in the bond markets. This first-mover advantage, plus the fund’s outsized discount, sets us up for more upside and gives us some downside “insulation” in the months ahead.

Muni-Bond CEF Pick #2: Nuveen Pennsylvania Quality Municipal Income Fund (NQP)

Just like BFZ, NQP has had a strong year, and investors are taking notice!

This is par for the course, since NQP has a 7.1% annualized return over the last decade that’s on the higher end for muni-bond CEFs. Yet NQP still trades at a 10.9% discount.

This is ridiculous, for a couple reasons. For one, NQP has a strong income stream: 4.3% yields flow to shareholders, and as with BFZ, this dividend stream looks ready to rise, thanks to growing income flowing into the fund from its bonds.

But NQP also has a portfolio of high-quality bonds (it focuses on the highest-rated bonds it can get, hence the “Quality” in the name), which makes it one of the less-volatile and lowest-risk muni-bond CEFs on the market.

Finally, Nuveen is another significant player in the bond market, and NQP is ideally positioned to get the best issuances from Pennsylvania before they’re released to the broader market.

Muni-Bond CEF Pick #3: BlackRock MuniYield New Jersey Fund (MYJ)

With MYJ, you’re getting the best of all worlds: strong management, a great discount and big income.

Let’s start with the yield: an outsized 4.7% dividend stream that is entirely sustainable, thanks to MYJ’s diverse portfolio of New Jersey bonds bought during market panics of years past.

And that’s nothing compared to its long-term performance!

MYJ trades at a respectable 5.1% discount to NAV, and its managers, BlackRock once again, get to choose the best issues from New Jersey’s massive and diversified economy, thanks to their big presence in the state and heft in municipal-bond markets. Own MYJ and you can capitalize on that unique market access.

Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Safe 8.5% Dividends.”

Disclosure: none

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