EIM: Lock in high yields for decent potential total return in Munis

Introduction

A research report from Nuveen revealed some key insights about the municipal bond market, and Nuveen also issued a very bullish outlook, in Municipal Bonds: Poised for Growth in a Bearish Market.

The the report was made based on market information available at the end of Q2 2024. While the Muni market outlook remains very similar, macro conditions such as rate cuts and economic data have changed. On the other hand, most Muni funds have been quite erratic over the past two months or so, the much anticipated recovery in Muni bonds has yet to occur. I view it as a key consolidation phase before the next move out of the current narrow trading range. Many institutions (funds) have actually increased their positions in Muni funds. Eaton Vance Municipal Bond Fund (NYSE: EIM) is a good example of such a Muni fund. I recommend interested investors to follow the cash flow and buy EIM shares right now and lock in the high yield. EIM has a dividend yield (federal tax free) of 5.84% and a discount to NAV of 8.74%. I expect a decent total return for EIM in 2024, assuming rate cuts start in September. The high yield and superior credit quality make it a good holding company for long-term income investments.

EIM fund overview

EIM is a Muni bond CEF managed by Eaton Vance. It was launched on August 30, 2002, 3 years after Eaton Vance launched its sister fund EVN.

The fund focuses on a portfolio of municipal bonds from various states. In the current portfolio, the top two states are New York with 10.04% share and Texas with 9.04% share. The next tier includes Florida, Ohio, California, Pennsylvania with less weights as shown below:

Total holdings are 213, which is smaller than some of the larger Muni funds and ETFs, where more than 500 or even 1,000 municipal bonds can be found in portfolios. It’s still a well-diversified bond portfolio, with the top 10 holdings weighing 19.26%, as shown below.

The following summarizes some of the key features of EIM:

• AUM: $651.19 million.
• Volume (last day): 57,032. Volume is a bit tight for trades.
• Established: August 30, 2002.
• Yield: 5.84%. High tax-free yield.
• NAV (discount): 8.74%.
• Expense ratio: 1.09%. The expense is slightly higher than its sister fund (0.98%).
• Risk Score (Morningstar): 21. Considered “conservative“.
• Credit (A or higher): 85%. Credit is from high quality.
• Duration (modified): 7.89 years.
• Leverage: 29.20%. It’s highly leveraged, though lower than the average CEF and some high-yield muni funds, with leverage as high as 30 percent.

The dividend distribution was recently increased in July, which is the second increase in 2024, as shown below:

Note that the increased portion in 2024 was mainly funded by the ROC as indicated below:

Favorable macro scenarios make Muni funds attractive potential short-term winners

Municipal bond markets are highly fragmented and often highly illiquid in trading. Individual investors like me can be overwhelmed by so many options. It will be much easier to select Muni funds (covering hundreds or even thousands of Muni bonds in portfolios) based on fund properties and characteristics such as AUM, yield, NAV discount, leverage, etc. These have proven to be fairly stable identifiers for funds with a long track record. Investors should spend more time focusing on macro conditions and portfolio positioning.

As indicated at the beginning of the introduction, Nuveen sees the Muni market as favorable for growth.

Investors are confident that both Treasury and municipal rates should be lower by the end of the year, so they are looking to lock in higher rates now.

For investors looking for price gains, lower rates will mean higher prices. I believe bond price appreciation will be sufficiently reflected in Muni funds. In addition, funds with better bond selections are expected to be the price winners. EIM is a good choice with the best rated bonds (A or higher).

Rate cuts could also help reduce the cost of leverage, as many Muni funds use high leverage. It is also possible that the potential rate cut cycle will officially begin with the first cut. These are the times when CEFs, including Muni funds, tend to perform well. Similarly, EIM’s 29% leverage could have positive effects on the fund’s returns.

Note that investors are often offered alternatives from the same issuer. This will provide some flexibility to select funds that can meet specific investor requirements such as diversification, durations, etc. The following is a key summary of EIM EVN’s partner fund, provided for reference purposes.

EVN – Eaton Vance Municipal Income Trust

• AUM: $454.59 million
• Volume (last day): 94,836.
• Established: January 29, 1999.
• Yield: 5.68%. High tax-free yield.
• NAV (discount): 5.50%. It is a smaller discount than EIM.
• Expense rate: 0.98%. It is smaller than EIM.
• Risk Score (Morningstar): 26. Considered ‘Moderate’, higher than EIM.
• Credit (A or higher): 57%. Lower quality than EIM.
• Duration (modified): 7.89 years.
• Leverage: 24.79%. It is less than EIM.

Note some key differences compared to EIM. EVN has a lower credit quality and higher risk score than EIM. On the other hand, EVN has received a 5-star rating from morningstar.com, while EIM is rated 3 stars.

There has been continued accumulation of new positions in Muni funds

Many funds put new money into EIM in 2024 as shown below. Notice the two large percentage changes, one is over 40% and the other is over 34%.

It’s worth noting that its sister fund EVN has received relatively less attention, despite its better Morningstar rating (5 stars). I think it is due to the lower discount to NAV (5.5% at the moment) which can be seen as more expensive than EIM.

Note that active Muni ETFs have also attracted a lot of interest and money flows. It was recently reported that investors “Suddenly, you have a lot more active Muni ETFs to choose from“. One of the ETFs highlighted is the Active CGMU ETF, as shown below:

CGMU gained approximately $1 billion in AUM to reach over $2 billion in a short period of time.

I think the “big money” has been gearing up for capital gain from Muni funds in 2024 in anticipation of a rate cut from the FED. Notice that CGMU pays a 3.1% dividend (tax-free), which is much lower than high-yield Muni funds. EIM offers a better dividend at 5.8%. Higher yields, like over 7%, aren’t hard to find in Nuveen’s Muni CEFs. Interested readers can find some details in my previous review. Note that some of Nuveen’s Muni funds have also seen significant cash inflows. While EIM stands out for its high-quality holdings and high yield, new money in CGMU would likely seek price “alpha” in the shorter term.

Risks and warnings

Note that the Muni market may be affected by the seasonal increase in supply from the new Muni bond issue. For example, “Muni bond yields may come under pressure due to heavy issuance,” noted the report from Nuveen (see link at top).

This may explain the short-term price behavior of these funds, but it certainly represents the risk of price volatility, which is very sensitive for some income investors.

CEF’s high leverage is still a risk factor and still subject to volatility, even after a potential rate cut in September. The overall performance yield could still be affected and become uncertain.

Closing thoughts

EIM is a solid long-term holding for income investors due to its high-quality credit rating, with A or above ratings covering more than 85% of the portfolio. The high-yield fund (5.8%, federally tax-free) offers a good choice for income investors who want to get into the Muni space without having to select individual bonds themselves. The current rate cut plan and possible rate cut cycle could be strong tailwinds for EIM to reduce its NAV discount (8.74%) and produce an attractive total return in the near term. EIM has seen quite a lot of money flows from top institutions/funds. Income investors may want to get in now to lock in the high yield and wait for possible price appreciation in 2024.