Editor’s note: As of 9/20/11 Lucas Krupinski no longer manages a Covestor model
Invesco/Van Kempen Municipal Trust (NYSE: VKQ) is a diversified, closed-end management investment company. The Trust’s investment objective is to provide high level of current income exempt from federal income tax, consistent with preservation of capital. It seeks to achieve the investment objective by investing primarily in municipal securities that are rated BBB or higher by Standard & Poor’s (S&P) or Baa or higher by Moody’s at the time of purchase.
Lucas Krupinski manages Covestor’s Small Cap Fundamentals model, which seeks to generate returns through a variety of methods including with preference for smaller cap issues. Krupinski recently added VKQ to this model, so we asked him to share his reasons for the purchase. His response follows.
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I don’t dispute that we are suffering from a certain amount of debt overload in the country, but there is (to me) the reality that if the U.S. Government defaults in its obligations, what occurred a couple of years ago will look like a walk in the park. So to stage investments on a premise of a defunct dollar just doesn’t seem like a worthwhile endeavor.
During the “flight to safety” panic that ensued, the public pushed T-Bills into negative yield territory briefly, and in the ensuing QE & QE2, the Federal Reserve has done its job at keeping yields down for longer duration bonds, something that I think will be ending and bear positively in my short position on PIMCOS 25+ Year Zero Coupon Gov’t Bond ETF (NYSE: ZROZ). Meanwhile, other investors looking for yield have crowded into the high yield space, pushing yields there down as well.
Credit Suisse High Yield Bond Fund (DHY), a former favorite of mine, now (as of 5/25/11) trades at 10% premium to NAV. That still provides a very respectable yield, but I think there’s too much risk of principal erosion should high yield lose popularity, and therefore send it to trading a steep discount to NAV instead. Moreover, its dividends are actually distributions of interest payments, and therefore taxed at ordinary income rates.
That’s the background that springs to my mind concerning fixed income investments.
Meanwhile, take VKQ (Van Kempen Municipal Trust). Its most recent fact sheet [PDF] spells out almost everything I could say about it. It’s an actively managed municipal bond fund that concentrates investments outside those that are highest rated. With an average coupon of 5.6% and a 40% leverage ratio, the yield is significant.
Finally, the premium to NAV that scares me about DHY does not exist in VKQ. As of 5/25, VKQ sells at the same level as its NAV (as reflected in ticker MUTF: XVKQX). I should note that VKQ is not a single state fund, but if one lives in a state without state income tax, there are generally no tax ramifications to buying such bonds from outside one’s home state.
Sources:
“Treasury Bills Trade at Negative Rates as Haven Demand Surges” Daniel Kruger and Cordell Eddings. Bloomberg, 12/9/08. https://www.bloomberg.com/apps/news?sid=aOGXsWKEI6F4&pid=newsarchive
“Credit Suisse High Yield Bond Fund Historical Prices” Yahoo Finance, http://finance.yahoo.com
“Invesco Closed-End Fund Monthly Information” Invesco. https://www.invesco.com/pdf/VK-CE-MUNI-FCT-1-E.pdf?contentGuid=301691f7166cc210VgnVCM1000000a67bf0aRCRD
Pricing information from Yahoo Finance. http://finance.yahoo.com
