Money managers led by John Nuveen Co and Pacific Investment Management Co are selling closed-end municipal bond funds at the fastest pace in eight years, tapping into rising investor demand for tax-exempt income.
Investment firms have started 15 closed-end muni funds this year and have another 14 ready to go, the most since 1993, according to fund tracking firm Lipper. Not a single fund was started last year, while 22 were introduced in 1999.
Managers of the funds are capitalizing on increased investor demand for bonds following a year in which the Nasdaq Composite Index has lost half its value. Falling interest rates and increased sensitivity to taxes have also made closed-end muni funds a popular bet among investors, investment advisers say.
"This year is likely to be an important year for the closed-end bond market," said William Fitz-gerald, head of the municipal bonds at Nuveen Investment Management, the largest closed-end muni fund manager with US$29.6 billion in assets.
Pimco, the world's largest bond manager, last week began selling closed-end funds for the first time, raising US$630 million for a national muni fund, a California fund and a New York fund.
Newport Beach, California-based Pimco, a unit of Germany's Allianz AG, managed more than US$3 billion of municipals before the sales, mostly in separate accounts for wealthy individual investors, spokesman Phil Neugebauer said.
Nuveen has started 12 closed-end muni funds this year, and has filed with the Securities and Exchange Commission for nine more. BlackRock Inc., a unit of PNC Financial Services Group, has filed for five closed-end municipal funds.
Unlike open-end mutual funds, whose shares are priced once a day based on the value of their holdings, closed-end funds issue a fixed number of shares that trade on exchanges. A closed-end fund's share price can differ from the value of its assets.
The closed-end structure is popular for municipal bonds and other types of relatively illiquid assets because fund managers don't run the risk of having sell assets to meet redemptions.
Falling interest rates also increase the appeal of closed-end bond funds because they can borrow up to 50 percent of the value of their assets and reinvest them to boost returns.
Nuveen's Fitzgerald said that by borrowing at tax-exempt short-term rates of about 3 percent and investing the proceeds in 30-year municipal bonds yielding 5.4 percent, the firm can raise a close-end fund's yield by 0.5 percentage point.
"This is something an individual cannot do in their own portfolio," Fitzgerald said.
Closed-end muni funds that use leverage gained 2.9 percent this year through June 30, compared with 2.4 percent for open-end muni funds, according to Lipper. Among top-performing funds, ACM Municipal Securities Income Fund, managed by Alliance Capital Management LP, gained 5.7 percent. Muniholdings Fund II, a Merrill Lynch & Co offering, gained 5.6 percent. The average domestic taxable bond fund gained 2.4 percent over the period.
Demand for bond funds in general has risen this year after two years of outflows. According to the Investment Company Institute, the fund industry's trade association, investors added US$32.8 billion to bond funds during the first five months of this year. During the same period last year, they took US$40.4 billion out of bond funds while stuffing US$193.2 billion into stock funds. "People are in a cautious mood," said Donald Cassidy, senior research analyst at Lipper.
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