Van Eck Launches ETF Holding Muni Bond Closed-End Funds

In the never ending search for yield, Van Eck Global launched the first ETF to focus solely on closed-end funds that hold municipal bonds.

The Market Vectors CEF Municipal Income ETF (XMPT) began trading Wednesday on the NYSE Arca. The big benefit to owning closed-end funds is that they can use leverage in the fund to boost their yield. And, of course, the benefit to owning municipal bonds, is that their interest is federally tax-exempt. So, the idea here is to get a high yield without paying the 15% tax rate imposed upon the dividends paid by stocks.

The fund tracks the S-Network Municipal Bond Closed-End Fund Index, which is comprised of 88 closed-end funds (CEFs). Leveraged municipal fixed-income CEFs make up 84.4% of the index’s constituents. The remaining constituents are unleveraged municipal fixed-income CEFs (8.85%); leveraged high-yield municipal fixed income CEFs (3.83%); and unleveraged high-yield municipal fixed-income CEFs (2.92%). The index methodology assigns a greater weight to closed-end funds trading at discounts, potentially enhancing yield and providing the opportunity for capital appreciation.

The fund of funds is an interesting concept, but personally, I don’t like it. Essentially, you have an index fund, but it’s made up of many other funds, which are actively managed. So, while you know what funds you hold, you never really know what the funds actually hold.

Paul Mazzilli, the former Morgan Stanley analyst, who advised S-Network on the index, really likes CEFs. The big benefits of CEFs are that they can use leverage to boost their yield. He says the benefit of the fund of funds is that you don’t have to research a lot of CEFs or deal with a lot of complicated tax issues, but you get much more diversification than you would by buying an ETF that held just municipal bonds.

However, the odds are that you get less diversification than is implied. I would assume that most of these closed end funds hold a lot of the same bonds, as well as many of the same bonds held by a muni bond ETF.

The main problem with the fund of funds is that in addition to the expense ratio charged by the ETF, the ETF needs to pay the expense ratios of all the funds it holds. This gives XMPT a gross expense ratio of 1.57% and a net expense ratio of 1.43%. However, fees are contractually capped at 0.4% until September 2012. What happens then is anyone’s guess.

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