The Wall Street Journal-20080216-Green Thumb- Despite Panic- Closed Munis A Safer Play

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Green Thumb: Despite Panic, Closed Munis A Safer Play

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Closed-end municipal-bond funds are usually one of the quieter and sleepier corners of the investment world. But they got hit by a wave of panicked selling in the past week, in a bizarre fallout of the great credit crunch.

This rush to sell has sent shares in some of these funds tumbling to levels that seem pretty cheap. Of course there will be more volatility ahead. But some funds are now selling for 90 cents for each dollar of underlying assets, or even less, and offering yields above 5% that are largely free of federal tax.

Closed-end funds are like ordinary mutual funds, except they issue a fixed amount of stock that trades like a regular share. Closed-end muni funds are often held by private investors seeking security and income -- precisely those most likely to get alarmed by volatility. No wonder the panic has been feeding off itself.

But investors need to distinguish between the preferred stock in these funds and the common stock.

The preferred stock, a form of short-term loan, has been hit by a liquidity problem. Not enough lenders are turning up for the weekly auctions. As a result, the current lenders have been unable to cash out.

They are still getting interest payments. But you can understand why they are furious.

It is possible that this freeze, if it lasts for a long time, could eventually affect the common stock as well. The fund companies might have to find ways to liquidate the preferred.

But right now the panic is leaving some of these common-stock shares looking pretty cheap, especially for anyone who needs long-term, tax- efficient income.

At $11.75, BlackRock MuniHoldings Insured Fund now yields about 4.9%. Morgan Stanley Insured Municipal Bond Trust, $12.46, yields 4.8%. Nuveen Premier Insured Municipal Income Fund, $12.80, yields 5% even. In all three cases, shares in these funds were selling for around 87 cents for each dollar of underlying assets.

BlackRock MuniYield Quality Fund, at $12.87, yields a little more, or 5.3%. It trades at a 10% discount to net assets.

These funds emphasize safety, and nearly all their bonds are investment grade.

Those offering more risk include BlackRock Municipal Income Trust. At $14.86, it yields around 6%. The shares trade at a modest premium, about 5%, to underlying assets. Nuveen Premium Income Municipal Fund, at $12.89, sells for about a 10% discount and yields 5.5%. These funds also invest in bonds below investment grade.

All these funds use leverage, which can increase short-term volatility. And some of their income may be subject to Alternative Minimum Tax. Investors need to consider their own circumstances, and to do their own homework.

The bigger risk for long-term bonds is probably inflation. But if you are looking for long-term income, these funds offer a better bet than the Treasurys, currently offering paltry, taxable yields.

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Caveats for Contrarians

Points to remember before buying in a panic:

-- Be prepared for more volatility. Panics can last.

-- Do your homework and understand what you're buying.

-- Know your tolerance for risk.

-- Buy small and often, not in one go.