Getting a Dollar for 90 Cents

By Charles Sizemore  |  January 22, 2020

I started 2020 by writing about my favorite go-to sources for income this year. I followed that up with guides on how to buy bonds and how to buy dividend stocks.

Today, we’re going to move on to one of my very favorite income fishing ponds: closed-end funds (CEFs) — specifically the tax-free variety.

So, let’s start with the basics.

What Is a Closed-End Fund?

CEFs are a type of mutual fund that trade on the New York Stock Exchange, and they work a little differently than traditional mutual funds and ETFs.

In a traditional open-ended mutual fund, you — or the brokerage house you use — send money to the mutual fund manager. The manager then takes your cash and uses it to buy stocks, bonds, and other investments. When you decide to sell and move on, the manager sells off a portion of the portfolio and sends you the proceeds. There is always money sloshing in and out of the fund.

Closed-end funds are different. They have an initial public offering (IPO) like a stock, and after that point the number of shares is fixed. Barring a secondary offering, a share buyback or tender (both of which are rare), new money does not enter or leave the fund. If an investor wants to buy or sell, they do so on the stock exchange.

From my description, CEFs look a lot like their cousins, ETFs. Both trade intraday on the stock exchange.

But there is one critical difference…

CEFs Versus ETFs

If the ETF shares are worth less than the underlying stock portfolio, the big boys can buy up ETF shares, break them open, sell the underlying stocks they hold, and walk away with a risk-free profit. Not bad work if you can get it!

But CEFs don’t have this mechanism in place.

This means you regularly get in situations where the price of the fund shares is vastly different than the value of the portfolio it owns. And this is when I get interested…

It doesn’t happen every day, but once in a while you can pick up a dollar’s worth of high-quality stocks and bonds for just 80 or 90 cents.

These are the opportunities I live for. In addition to the typical sources of return for mutual funds — capital appreciation and dividend yield — it introduces a third source of potential return as the discount closes to more normal levels.

Let’s look at an example…

A Third Source of Potential Returns

Out of fairness to my Peak Income subscribers, I can’t share with you any of my current open positions. But I’ll share one that closed out a couple years ago.

The Invesco Municipal Trust (NYSE: VKQ) owns a diversified portfolio of tax-free city, county, and state bonds. At current prices it pays 4.6%, which is respectable for a bond fund in this interest rate environment.

In December 2018, the shares traded at a 13.7% discount to book value, meaning investors buying at that price were buying a dollar’s worth of assets for 86 cents.

Not bad!

Now, fast forward to today… Shares now trade at a more normal discount of 6.7%.

That means that anyone holding VKQ over that period earned a 7% return not including the dividend payments and the appreciation of the underlying portfolio.

Over that same period, the underlying bond portfolio also enjoyed a nice run — returning about 5%. Adding the two together, you get 12% in capital appreciation plus the dividend. The monthly payout added another 5.6% for a total return of 17.6% in a little over a year in a boring, conservative bond fund.

Let’s take a deeper look at that dividend.

While realized capital gains on muni bonds are subject to federal taxes, the interest payments are not. They’re 100% tax free. VKQ’s monthly dividend, since it’s based on the tax-free coupon payments, is also 100% tax free.

If you’re in a high-tax bracket, the current 4.6% dividend starts to look a lot juicier.

In the 24% bracket, that 4.6% is equivalent to a 6.1% taxable yield.

In the 35% bracket, it’s equivalent to 7.1%.

And at the top 37% bracket, it’s equivalent to 7.3%.

Taxes are probably your single biggest impediment to accumulating real wealth, particularly if you’re pursuing an income strategy. Tax-free muni CEFs give you the opportunity to shelter your income from taxes while also growing your capital.

You have to be smart, of course, and buy them when they’re on sale.

And that’s something I regularly cover in Peak Income. To learn how you can start investing in ways that protect your money from “The Man,” simply click here.

In a League of His Own

In his brand new, Millionaire Masterclass, Adam O’Dell shows you the exact same strategy he’s used to build an investing track record better than that of George Soros, Carl Icahn and even… Find Out More>>
Charles Sizemore

Income and Retirement Strategist, Charles Sizemore, CFA specializes on dividend-focused portfolios and building alternative allocations by finding value opportunities outside of the mainstream stock market.

Charles is the executive editor and portfolio manager for Dent Research's premium newsletters, Peak Income and Peak Profits.

He is also a frequent guest on CNBC, Bloomberg TV, Fox Business News and Straight Talk Money Radio, and has been quoted in Barron’s Magazine, The Wall Street Journal, and The Washington Post. He is a frequent contributor to Forbes, GuruFocus, MarketWatch and

Charles holds a master’s degree in Finance and Accounting from the London School of Economics in the United Kingdom and a Bachelor of Business Administration in Finance with an International Emphasis from Texas Christian University in Fort Worth, Texas, where he graduated Magna Cum Laude and as a Phi Beta Kappa scholar. MORE FROM AUTHOR