Muni closed-end funds are mutual funds that hold only municipal bonds and trade like stocks. They offer tax breaks for investors in high tax brackets and provide diversity in investments. Share prices are based on the value of underlying bonds and supply and demand.
Muni closed-end funds are a type of mutual fund that holds only municipal bonds. Mutual funds are typically bought and sold once a day after the stock market closes, while closed-end mutual funds trade like stocks, meaning shares can be bought and sold throughout the day. People in high tax brackets often buy these types of funds because these investments pay dividends that are usually not taxable.
Municipalities sell two types of bonds: general bonds and tax bonds. Government entities sell general bond bonds to raise money for short-term expenses, such as wages and law enforcement. Bondholders lend money to the government over a period of time, and the government pays tax-derived interest payments to the bondholders. Income bonds are sold to raise funds for municipal income-generating projects, such as airports. Bondholders receive interest payments based on the income generated by the completed project.
In the United States, the federal government does not assess taxes on either the interest payments of municipal bonds or the dividends paid by muni closed-end funds. Investors who purchase bonds issued by a local government, headquartered in the state where they live, do not have to pay state income tax on interest. People with high tax burdens often buy municipal bonds or muni closed-end funds to take advantage of these tax breaks.
Muni closed-end funds begin with an initial public offering during which shares are sold to investors and funds are raised to purchase the underlying municipal bonds. Investors cannot buy into the fund after the initial public offering, but can buy shares on the secondary market from existing shareholders. Muni funds pay a regular dividend which is based on the interest payments the fund company receives for the bonds it holds.
The primary advantage that closed-end muni funds have over individual municipal bonds is diversity. If a tax-bond-funded project or municipal government fails, bondholders risk losing all of their money. Closed-end Muni funds contain thousands of bonds issued by different government entities, so if a city government goes bankrupt it impacts the fund but doesn’t cause shareholders to lose their entire investment.
The share prices of muni closed-end funds are partly based on the value of the underlying bonds, but are also dependent on supply and demand. Shareholders must negotiate a sale price when selling shares. During a booming market, a shareholder may be able to sell a stock for a higher price, while during a market downturn, shareholders often have to sell a stock for less than its true value.
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