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The Hidden Value in Municipal Bond Closed-End Funds


TOM BUTCHER: Paul, why may municipal bond closed-end funds be attractive for investors right now?


PAUL MAZZILLI: There are three attractive aspects of municipal closed-end funds, all of which are working together right now. The first, as a closed-end fund, they have a set investment, they're run by professional managers, and since they don’t having assets come in and out like an open-end mutual fund, they can buy less-liquid, higher-yielding securities like private placements, non-rated bonds, and they're not forced to sell bonds when people are seeking out liquidity. The next is a unique aspect of municipal closed-end funds. They have the ability to leverage. When a closed-end fund leverages, it will borrow against its own assets and buy more bonds. Here is a simple example: For a $100 million closed-end fund, the most its allowed to borrow is one-third leverage. It can borrow $50 million and buy another $50 million of bonds. The $100 million in assets becomes $150 million invested. If the underlying bonds are yielding 4%, the leveraged fund would yield 6%, approximately, before any incremental costs. You get almost a 50% increase given this ability to leverage one third.


The final thing is that after closed-end funds are issued, they trade as stocks in the marketplace. Based on demand and supply, they can trade rich to their value [at a premium], or they can trade cheap to their value [at a discount]. Right now, they're selling historically cheap at about a 10% average discount. The 25-year average discount is approximately 2%. So when you're selling at a 10% discount, if you're buying a dollar of assets for $0.90, if you had an asset yielding 10%, you're actually getting an 11.1% yield on the money you're putting up.


This fact that they're trading at a discount is happening right now because investors are fearful of the Fed raising rates. They are fearful of the equity markets, they've been raising cash since they've traded stocks, they're selling them, they're not looking at the underlying value, and it's created a real buying opportunity. The discount has one other final advantage: If bonds were to sell off, but you're buying at a 10% discount and it goes to a 5% discount, you actually could have a capital gain, even though the underlying bonds sell off.


BUTCHER: Is the prospect of debt restructuring in Puerto Rico going to have any impact on municipal bond closed-end funds?


MAZZILLI: Very good question. I think there are two different aspects. First, what does Puerto Rico do to the general municipal bond market? It is a significant issuer. It could have some impact in terms of how bonds trade. I personally believe a lot of that is already reflected in the market. Second is, what does it do to our index of municipal closed-end funds [S-Network Municipal Bond Closed-End Fund Index, CEFMX]? Our index currently has a very low exposure of about 0.43% to Puerto Rico. And that comes from two reasons. One: municipal closed-end funds tend to buy higher-quality funds, which would exclude Puerto Rico right now, or in the past. Two, we buy only national municipal closed-end funds, or our index represents only national municipal closed-end funds. And the national funds buy very little Puerto Rico exposure because they have a lot of other ways to diversify.


BUTCHER: Paul, thank you very much for joining me today.


MAZZILLI: Thank you.


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IMPORTANT DISCLOSURE


The views and opinions expressed are those of the speaker and are current as of the video’s posting date. Video commentaries are general in nature and should not be construed as investment advice. Opinions are subject to change with market conditions. All performance information is historical and is not a guarantee of future results. For more information about Van Eck Funds, Market Vectors ETFs or fund performance, visit vaneck.com. Any discussion of specific securities mentioned in the video commentaries is neither an offer to sell nor a solicitation to buy these securities. Fund holdings will vary. All indices mentioned are measures of common market sectors and performance. It is not possible to invest directly in an index. Information on holdings, performance and indices can be found at vaneck.com.


Diversification neither assures profit nor protects against loss.


Please note that Van Eck Securities Corporation offers investment products that invest in the asset class(es) included in this video. Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer’s financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. Municipal bonds may be less liquid than taxable bonds. There is no guarantee that the income generated will be exempt from federal or state income taxes, and changes in those tax rates or in alternative minimum tax rates or in the tax treatment of municipal bonds may make them less attractive as investments and cause them to lose value. Gains, if any, are subject to gains tax.


S-Network Municipal Bond Closed-End Fund IndexSM is calculated and maintained by S-Network Global Indexes, Inc©. S-Network does not sponsor, endorse, or promote the Fund and bears no liability with respect to the Fund or any security.


S-Network Municipal Bond Closed-End Fund Index is a rules based index intended to serve as a benchmark for closed-end funds listed in the US that are principally engaged in asset management processes designed to produce federally tax-exempt annual yield.


Index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Investors cannot invest directly in the Index. Returns for actual Fund investors may differ from what is shown because of differences in timing, the amount invested and fees and expenses. Index returns assume that dividends have been reinvested.


Investing involves substantial risk and high volatility, including possible loss of principal. An investor should carefully consider the investment objective, risks, charges and expenses of the Fund before investing. Bonds and bond funds will decrease in value as interest rates rise. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.


No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Securities Corporation. © Van Eck Securities Corporation.


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