Hedge Funds Are Buying Municipal Bonds

Municipal bonds are created as a source of funds for toll roads, schools, hospitals and other projects.  These bonds are tax-exempt from Federal tax and some states.  Individual investors like to buy munis in their taxable accounts to escape income taxes.  During the economic crisis, mom and pop investors moved into munis to seek stability and income.

Recently, the trend has changed due to fear of bond defaults.  Stock analyst Meredith Whitney issued a warning that there is a high probability of   muni bond defaults.  It is true that many states and cities are upside down on their debts.  Illinois increased its state tax 66% to deal with its own credit crisis.  The result of increasing muni bond defaults has scared retail investors who pulled $25 billion from munis in the last 3 months.  History tells us that retail investors have poor market timing.

Is anyone buying munis today?  Yes.  Hedge funds are currently buying the munis sold by retail investors.  Both Moore Capital and Oak Tree Capital have been increasing their stake in muni bonds.  Their rationale is the value of munis is cheap.  When bond values are low, the income yield is high.  Hedge funds, classified as smart money, is looking for a price rebound while getting paid income to be patient.

How can you get in on this value play?  There are many closed-end funds that invest in munis and pay monthly income.  One investment to evaluate is the Nuveen Muni High Income Opportunity Fund (NMZ).  This fund is trading at $11.46 with a 10% premium to net asset value.  The distribution rate is 8.75% which is a taxable equivalent yield of 13.45%.  This is very competitive with high yielding monthly income funds that are taxable.  A fund like NMZ is a great opportunity for taxable investing accounts.

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