View from the Observation Deck

1. Investors seeking current income free from federal income taxes have a number of vehicles to choose from. One is Municipal Bond Closed-End funds.
2. The closed-end fund structure differs from its open-end counterpart primarily in that the number of shares issued are fixed when the fund is launched at its IPO.
3. Once issued, the shares trade on an exchange, like a stock. Management does not have to account for capital inflows or outflows from investors, which allows them to remain fully invested if they so desire.
4. A high percentage of closed-end funds employ some form of leverage. In other words, the fund borrows additional capital to invest on behalf of its common shareholders.
5. Leverage can come in the form of a credit line, issuance of preferred shares such as Auction Rate Preferreds, or other forms.
6. The goal of leveraging is to earn a positive spread between the cost of capital borrowed and the securities bought with said capital. The spread (after fund expenses) is then distributed to the common shareholders.
7. In addition to generating more income, investors should know that leverage does increase the volatility of a fund in terms of share price. And there is no better example than 2008.
8. The global credit crisis of 2008 dealt a crushing blow to Municipal Bond Closed-End funds. The Auction Rate Preferred market literally froze to the point where many investors could not access their capital for months.
9. Investors wanted nothing to do with leverage. The federal bailout of Wall Street, while unpopular in many circles, did eventually help unfreeze the credit markets and restore confidence.
10. The chart above shows that Municipal Bond Closed-End funds outperformed the Barclays Capital Municipal Bond: Long Bond (22+) Index for the past 1-, 3- & 5-Year periods, on an NAV and market price basis.
11. The 3- & 5-Year returns are average annual total returns.