UNCOVERING VALUE IN MUNICIPAL CLOSED-END FUNDS August 215 BlackRock believes that municipal bonds can offer attractive income potential both on a relative and tax equivalent basis. BlackRock further believes that municipal closed-end funds ( CEFs ) can enhance that income potential through active management and the use of leverage. Moreover, many municipal CEFs are currently trading at historically wide discounts to net asset value ( discounts ), which BlackRock believes can further enhance that income potential. Why Now? BlackRock believes that global interest rate volatility, combined with municipal bond underperformance relative to US Treasuries, has presented opportunities in the both the municipal bond and municipal CEF markets. For example, as of 7/31/15, the 1-Year AAA municipal yield was 2.4% versus the 1-Year U.S. Treasury yield at 2.18% or a 11% municipal-to-treasury ratio (Exhibit 1). When adjusted for investors in the highest tax bracket, the 1-Year AAA municipal yield increases to an estimated 4.27%*. EXHIBIT 1 The municipal-to-treasury yield ratio at 11% remains above its long-term average of 98%. 2% Similarly, the Morningstar National Municipal Closed-End Fund Index (Leveraged) currently yields 5.6% on a net asset value ( NAV ) basis. However, given the investors ability to buy municipal CEFs in the market at an average discount of -8.%, that yield increases to an estimated 6.9% on a market price basis, or an estimated 1.84%* for investors in the highest tax bracket. BlackRock believes, given current yield and discount levels, that municipal CEFs could be attractive to investors seeking the potential for tax efficient income. EXHIBIT 2 Leveraged national municipal CEFs have traded at a higher valuation on 88% of the days since 1997. 4 88% of observations are narrower than 7/31/15 3 15 7/31/15 Muni CEF 8.% discount 2 1 1 5 7/1 7/3 7/5 7/7 7/9 7/11 7/13 7/15 1Y Muni-Tres Ratio (11%) Average (98%) -2. -16. -12. -8. -4.. 4. Source: Bloomberg, data from 1/2/21 to 7/31/215. Past performance does not guarantee and is not an indication of future results. Source: Morningstar, as of 7/31/215. Past performance does not guarantee and is not an indication of future results.
Implementation Municipal CEFs can be used both strategically (i.e. buy and hold) and tactically (i.e. mean reversion) in an effort to generate income for tax sensitive investors. BlackRock believes, given current discount levels, that municipal CEFs could be attractive to investors implementing strategic or tactical allocations. Notably, while the use of leverage by a CEF may potentially enhance income, leverage may also increase the interest rate sensitivity of a portfolio. CEFs that use leverage tend to have longer durations as the funds borrow at the short end of the yield curve and buy longer dated bonds. This dynamic makes CEFs more interest rate sensitive than many of their open-end fund counterparts. Therefore, BlackRock believes that a barbell strategy that combines a leveraged municipal CEF with a short duration municipal exchange-traded fund (ETF), such as ishares Short Maturity Municipal (MEAR), may enhance income potential while maintaining a duration profile similar to that of an intermediate duration national municipal open-end fund (Exhibit 3). EXHIBIT 3 BlackRock believes that pairing leveraged national municipal CEFs, like the BlackRock MuniYield Quality Fund III, Inc. (MYI), with a short duration national municipal ETF can potentially lower your portfolio duration while generating higher income than intermediate duration national municipal open-end funds. 1% Morningstar OE Municipal National Intermediate Category 1% BlackRock MuniYield Quality Fund III, Inc. (MYI) 1% ishares Short Maturity Municipal (MEAR) 57% BlackRock MuniYield Quality Fund III, Inc. (MYI) 43% ishares Short Maturity Municipal Portfolio 1% Morningstar OE Municipal National Intermediate Category (Equal Weight) 1% BlackRock MuniYield Quality Fund III, Inc. (MYI) 1% ishares Short Maturity Municipal Bond ETF (MEAR) 57% BlackRock MuniYield Quality Fund III, Inc. (MYI) 43% ishares Short Maturity Municipal Effective Duration 4.91 Years 7.67 Years 1.27 Years 4.91 Years Yield 1.59% 6.32%.89% 4.% Source: BlackRock, Morningstar, as of 7/31/215. BlackRock MuniYield Quality Fund III, Inc. (MYI) is being represented because it is the largest BlackRock perpetual national municipal closed-end fund. MYI s NAV annualized total return performance on a 1 year, 3 year, and 5 year basis is 5.72%, 4.89%, and 7.99%, respectively. Past performance does not guarantee and is not an indication of future results. The Discount Dilemma Since the taper tantrum in May 213, when the Federal Reserve signaled its willingness to taper bond purchases due to sustained economic progress, investors have remained skeptical of a potential rise in interest rates following the initial increase in the Fed Funds Rate. BlackRock believes that the prevalence of discounts in the municipal CEF market may reflect the uncertainty of future interest rate expectations given the municipal CEFs exposure to duration risk and higher leverage costs amid a rising interest rate environment. As illustrated in Exhibit 4, municipal CEFs currently trade at an -8.% discount, which is well below their 5-Year average of a -2.9% discount. BlackRock believes that the market may currently reflect the potential negative impact of rising interest rates, which may dampen share price volatility when the Fed signals their first increase in the Fed Funds Rate. Based on EXHIBIT 4 Leveraged national municipal CEF valuations remain well below their 5-Year average of a -2.9% discount. 6-6 -12 7/1 7/11 7/12 7/13 7/14 7/15 Leveraged National Municipal CEFs (-8.) 5-Year Average (-2.9) Source: Morningstar, data from 7/1/21 to 7/31/215. Past performance does not guarantee and is not an indication of future results. Leveraged national municipal CEFs are represented by the Morningstar Municipal Closed-End Fund Index (Leveraged).
EXHIBIT 5 Leveraged national municipal CEFs exhibited a positive total return during the last rising rate period. Additionally, leveraged national municipal CEF valuations are nearly double their historical average. Portfolio Source: Morningstar, as of 7/31/215. Annualized Total Return Max Drawdown Premium/ Discount (Avg) 3 Tax-Equiv Yield (Avg) 4,5 Since 1997 1 8.86% -28.11% -4.37% 1.59% 24 to 26 8.62% -7.71% -5.48% 1.17% 213 to Present 5.62% -14.59% -5.81% 1.36% 215 YTD 2 -.51% -3.96% -8.38% 1.7% this dynamic, BlackRock believes that current discounts may represent a value opportunity for investors seeking the potential for tax efficient income. Framing the Opportunity When comparing municipal CEF performance during the 24 rate hiking cycle relative to the market reaction during the taper tantrum in 213, we found a similar sell-off in both the underlying portfolio (lower bond prices) and at the fund level (widening discounts). However, valuations quickly recovered in 24 versus today s persistently wide discounts. BlackRock believes the primary differentiator was the Fed s action to increase the Fed Funds Rate in 24 versus the Fed s continuing inaction in the market today. BlackRock believes that this uncertainty may be one reason why municipal CEF valuations have fluctuated near historic lows since the second half of 213. Municipal CEFs have a long track record of providing a high level of tax efficient income and strong total returns. Since 1997, an unweighted basket of leveraged national municipal CEFs has returned 8.9% annually, including a 1.59%* taxequivalent yield (Exhibit 5). BlackRock believes investors should opportunistically allocate to municipal CEFs given their strong historical track record and the prevalence of discounts in the market. Potential Higher Income Through the Use of Leverage Municipal CEFs can utilize leverage to enhance income potential. In general, the shape of the municipal yield curve is upward sloping, meaning that short-term rates are lower than long-term rates. Municipal CEFs employ leverage by borrowing at short-term rates and reinvesting proceeds at long-term rates, thus earning the spread between the two rates. Notably, we found that since 21, the average spread between the short-term rates and the long-term rate has been 3.43% (Exhibit 6). Moreover, that spread turned negative just.3% of the time since 21, spanning a matter of 12 days in late-28. It is important to note that if the spread between short-term rates and long-term rates contracts, this can lower a fund s earnings and can potentially lead to distribution reductions in the CEF. EXHIBIT 6 Leveraged national municipal CEFs can enhance income potential by employing leverage to capture the spread between short-term and long-term interest rates. 6 3-3 7/1 7/2 7/3 7/4 7/5 7/6 7/7 7/8 7/9 7/1 7/11 7/12 7/13 7/14 7/15 Spread (4.51%) Average (3.43%) Source: Bloomberg, data from 1/2/21 to 7/31/215. Past performance does not guarantee and is not an indication of future results. 1 Distribution Rate (Avg) from 23 to Present. 2 Cumulative Total Return YTD. 3 Discount as of 7/31/215. 4 Taxable-Equivalent Yield as of 7/31/215. 5 Assumes max 43.8% federal tax rate. Past performance does not guarantee and is not an indication of future results.
BlackRock believes that in the current low yield environment, as investors look to diversify their sources of income, municipal CEFs may provide attractive income opportunities. BlackRock believes that when evaluating municipal bonds, it is important to consider their taxequivalent yield. Municipal CEF s are currently offering an estimated tax-equivalent yield of approximately 1.83%* on market price, which is higher than the estimated yield for most traditional fixed income alternatives (Exhibit 7). BlackRock believes that including municipal CEFs in an investment portfolio may lead to higher total returns in the longer-term. Municipal CEFs have outperformed their open-end peers in 2 of the last 25 calendar years, on an NAV basis, including average annual outperformance of 3.7% over the last 25 years. EXHIBIT 7 Distribution rates for leveraged national municipal CEFs, when adjusted for taxes, exceed most traditional fixed income alternatives. 12 8 4 US Treasury US Corp Inv Grade Muni 1 US Corp BlackRock High Yield Nat Muni CEF 1 Yield Duration Source: BlackRock, Barclays, as of 7/31/215. Past performance does not guarantee and is not an indication of future results. Note: Index yields are based on yield-to-worst, CEF yield is bases on market price. 1 Tax-Equivalent Distribution Rate calculated using a 43.8% effective tax rate. Indexes use modified adjusted duration and BlackRock National Muni CEF uses effective duration. EXHIBIT 8 Municipal CEFs have outperformed both municipal mutual funds and the Barclays Municipal Bond Index over the last 1 years. 9.% 6. 3. 6.42 3.56 2.31 2. 2.81 4.68 7.68 4.39 3.6 3.71 4.57 5.81. 1 Year 3 Year 5 Year 1 Year Municipal Mutual Funds Barclays Municipal Bond Index Municipal Closed-End Funds Source: Morningstar, Barclays, as of 7/31/215. Past performance does not guarantee and is not an indication of future results. Performance is net of fees. Municipal Closed-End Fund returns are based on net asset value and are represented by the Morningstar national municipal Closed-End Fund Index (Leveraged). Municipal mutual funds are represented by the Morningstar OE Municipal National Intermediate Category. EXHIBIT 9 Total return difference between municipal CEF NAVs and municipal mutual fund NAVs over the last 25 years. Municipal CEFs outperformed in 2 of the 25 years. 2. 1.. -1. -2..6 1.9 1.4 2.5 4.8 4.7 1. 1. 1.1.7 3.2 3.4 2.7 2.8 2. -2.1-2.7-1.5-11.4 15.5.5 7.4 6.7-3.4 1. Source: Lipper, as of 7/31/215. Performance is net of fees. Past performance does not guarantee and is not an indication of future results. Municipal CEF returns are based on net asset value and are represented by the Lipper General & Insured Municipal Funds (Leveraged) category. Municipal mutual funds are represented by the Lipper General & Insured Municipal Funds category.
Want to know more? blackrock.com BlackRock does not provide tax advice, and investors should consult their professional advisors before making any tax or investment decision. Performance results reflect past performance and are no guarantee of future results. Current performance may be lower or higher than the performance data quoted. All returns assume reinvestment of all dividends. The market value and net asset value (NAV) of a fund s shares will fluctuate with market conditions. Closed-end funds may trade at a premium to NAV but often trade at a discount. All return data assumes reinvestment of all distributions. Current performance may be lower or higher than the performance data quoted. In evaluating total return, investors should take into account the effect of federal, state and local income and other taxes payable by the investor on distributions received from a fund and any gain on the sale of fund shares. The extent and nature of such taxes may be affected by a fund s particular investment strategies and tax status, as well as the investor s own circumstances. Additional information regarding distributions can be found in a fund s annual and semi-annual shareholder report. For more information, please refer to blackrock.com. Investment return, price, yields and NAV will fluctuate with changes in market conditions. At the time of sale, your shares may have a market price that is above or below net asset value, and may be worth more or less than your original investment. There is no assurance that a fund will meet its investment objective. Closed-end funds, unlike open-end funds, are not continuously offered and do not provide daily liquidity. There is an initial public offering of shares and, once issued, shares of closed-end funds are purchased and sold in the open market on a stock exchange. Some BlackRock CEFs may utilize leverage to seek to enhance the yield and net asset value of their common stock, through bank borrowings, issuance of short-term debt securities or shares of preferred stock, or a combination thereof. However, these objectives cannot be achieved in all interest rate environments. While leverage may result in a higher yield for the fund, the use of leverage involves risk, including the potential for higher volatility of the NAV, fluctuations of dividends and other distributions paid by the fund and the market price of the fund s common stock, among others. There is no assurance that a fund s leveraging strategy will be successful. Once a portfolio is leveraged, the net asset value and market value of the common shares will be more volatile. While a common investment practice by many CEF managers, leverage cannot assure a higher yield or return to the holders of the common shares. Certain funds may invest assets in securities of issuers domiciled outside the United States, including issuers from emerging markets. Foreign investing involves special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. Some BlackRock CEFs make distributions of ordinary income and capital gains at calendar year end. Those distributions temporarily cause extraordinarily high yields. There is no assurance that a fund will repeat that yield in the future. Subsequent monthly distributions that do not include ordinary income or capital gains in the form of dividends will likely be lower. Note that all dividend and yield data is based on the current month s distributions. Index Descriptions: High Yield Funds (Leveraged) Lipper classification Funds that aim at high (relative) current yield from fixed income securities, have no quality or maturity restrictions, and tend to invest in lower-grade debt issues. These funds can be leveraged via use of debt, preferred equity, and/or reverse repurchase agreements. Corporate BBB-Rated Debt Funds (Leveraged) Funds that invest at least 65% of their assets in corporate and government debt issues rated in the top four grades. General & Insured Muni Debt Funds (Leveraged) Funds that either invest primarily in municipal debt issues rated in the top four credit ratings or invest primarily in municipal debt issues insured as to timely payment. These funds can be leveraged via use of debt, preferred equity, and/or reverse repurchase agreements. Income & Preferred Stock Funds Lipper classification Funds that normally seek a high level of current income through investing in income producing stocks, bonds, and money market instruments, or funds that invest primarily in preferred securities, often considering tax code implications. Loan Participation Funds Lipper classification Funds that invest primarily in participation interests in collateralized senior corporate loans that have floating or variable rates. Emerging Market Debt Funds Lipper classification Funds that seek longterm capital appreciation by investing at least 65% of total assets in emerging market equity securities, where emerging market is defined by a country s GNP per capita or other economic measures. S&P Municipal Bond Index - broad, market value-weighted index that seeks to measure the performance of the U.S. municipal bond market. Past performance is no guarantee of future results. Lipper rankings are based on total return using market prices. Closed-end fund shares are not deposits or obligations of, or guaranteed by, any bank and are not insured by the FDIC or any other agency. Each fund is subject to investment risk, including possible loss of principal amount invested. This is not a prospectus intended for use in the purchase or sale of any shares of any closed-end fund. Shares may only be purchased or sold through registered broker/dealers. For more information regarding any of BlackRock s closed-end funds, please call BlackRock at 8-882-52. No assurance can be given that a fund will achieve its investment objective. Closed-end fund shares may trade at a discount to net asset value (NAV). 215 BlackRock, Inc. All Rights Reserved. BLACKROCK is a registered trademark of BlackRock, Inc. or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. Prepared by BlackRock Investments, LLC, member FINRA. Not FDIC Insured May Lose Value No Bank Guarantee Lit. No. CEF-UNCVALUE-815 4774a-EF-151-815