Large municipal-bond funds run by BlackRock Inc., Nuveen, Pacific Investment Management Co. and Invesco Ltd. are unwinding a leveraged investment strategy that backfired this month, contributing to the flood of debt that’s been unloaded during a record-setting sell-off.
Last week, fund companies began liquidating about 75 so-called tender-option bond trusts holding $1.2 billion worth of state and local government debt, according to data compiled by Bloomberg. The trusts issue floating-rate notes to money-market funds and use the cash to buy higher-yielding long-term bonds. Mutual funds seek to pocket the difference in yield between the two.
The leverage employed by mutual fund companies has amplified losses in the closed- and open-end funds as rates climbed during the sell-off.
As of Friday, returns on 15 BlackRock closed-end muni funds that use tender-option bonds and preferred shares as leverage have dropped more than 20% this month and one, the BlackRock Maryland Municipal Bond Trust, has lost 30%, according to data compiled by Bloomberg. Five of Nuveen’s closed-end funds have lost more than 20% and one has lost 30.5%. Nuveen’s open-end High Yield Municipal Bond Fund, which also employs tender-option bonds, has dropped 21.7% this month.
Invesco and Pimco’s muni closed-end fund share prices declined 15% to 25% this month.
Those drops are far bigger than the overall municipal market’s. The Bloomberg Barclays index of investment grade munis has declined 10.3% this month, the biggest drop since at least 1980, and high-yield municipal bonds have fallen 19.1%.