DMB - DMB: High Expense Ratio Holding This Fund Back

2023-09-26 07:00:26 ET

Summary

• BNY Mellon Municipal Bond Infrastructure Fund focuses on regional government bonds related to infrastructure projects.
• The fund's distributions are tax-advantaged and relatively safe.
• The fund's distribution yield is held back by its high expense ratio, which affects its overall attractiveness as an investment.
• The fund should have been yielding much higher, considering its holdings, NAV discount and recent price drops.

BNY Mellon Municipal Bond Infrastructure Fund (DMB) is an income closed-end fund that focuses on regional government bonds mostly related to infrastructure spend. While I like this fund's diversification, safety and focus on infrastructure projects (and tax-advantaged status), I am having trouble rating it a buy because its distribution yield seems to be held back significantly by its high expense ratio.

Infrastructure is something expensive to build and almost as expensive to maintain. Regional governments need to invest a lot of money into their highways, airports, bridges, hospitals, power lines and other infrastructure so that their residents can go on with their lives without major disruptions. Many times these local governments don't have enough cash at hand to spend on these large and expensive projects so they borrow money in form of selling municipal bonds. These bonds might have slightly lower yield as compared to corporate bonds but they will have certain tax advantages such as their interest payments often being tax-free when filing Federal taxes.

DMB holds about 170 bonds from a variety of local governments across projects and many of these bonds actually tell you what project each bond is supporting. Many states (if not most) have laws stating that money borrowed for one project can't be used for another project and many county and city governments may put any additional bonds into a ballot prior to borrowing such money so that residents can decide whether they want to even pay for that bond before the local government borrows. For example when we look at the fund's top holdings we see many project specific bonds such as a bond from Muskingum County (Ohio) to be spent on hospital facilities. We see another bond from Long Beach (California) regarding natural gas projects. We also see a Denver bond dedicated to airport facility projects. It's important for investors (and tax payers) to know where their money is going to be spent so that they can figure out if it's worth the money and make relevant decisions.

When it comes to municipal bonds, credit ratings are important because local governments (whether it be a state, county, city or town) can't print money the same way the Federal government can (neither do they own a whole currency) so they have to be more careful with their budget. Although default rates of municipal bonds are extremely low as compared to corporate bonds, they are still not as "risk-free" as those Federal government bonds and treasuries. Having said that, we see that 35% of this fund's bonds are rated A, 10% rated BB and another 24% rated BBB by rating agencies. We don't see a lot of AAA ratings because very few local governments are granted that high of a rating at all since they can't print money. BBB and above should be considered investment grade with very low risk of default. Interestingly enough, 15% of the fund's bonds don't have a rating which can be concerning to more conservative investors.

The fund lists its top "Industries" but these aren't exactly industries since all bonds are issued by local governments which are considered public services. Another way to look at the list below is the types of projects which this fund's bonds are supporting. We see about 22% of the bonds (by weight) are supporting, which is no surprise since transportation is one of the first things that come to people's minds when one says infrastructure. We also see a high percentage of bonds supporting healthcare and education projects but again these are more on the infrastructure side of these areas such as building or renovating a local hospital facility or a school campus.

This fund trades at a -9.59% discount against its NAV. Historically this fund traded closer to its NAV and rarely traded at a small premium but it's rare for the fund to trade at a deep discount. The fund's current discount may not be specific to this fund though. I've seen other bond funds also trade at a discount in recent months because bond market is still in a bear market which started at the end of 2021 even though stocks seem to be doing much better since last year. If the Fed continues on with its hikes or holds rates higher for longer (as it's been communicating for a while) we might see this NAV discount to sustain or perhaps get even deeper but I doubt the Fed has more than a couple more hikes left in it at this point.

There are a couple things about this fund that I am not a big fan of though. The first one is its distribution yield. The fund currently yields only 4.9% when risk-free treasuries yield 5.5%. More importantly, when I look at this fund's holdings I see a lot of bonds with 5% or 5.5% coupons as you can see above in the top holdings list that I shared earlier in this article. If the bond holds a bunch of bonds with 5-5.5% coupons and it trades at an almost 10% NAV discount, you'd expect it to yield close to 6%. Also, since bond prices have been on a downtrend lately, a bond with original coupon of 5% is likely to yield already 6% by now. Why is this fund yielding only 4.9% then? One explanation I've found is that the fund's expense ratio is actually very high at 1.72% which eats into its yield. The fund generates a much higher yield from its assets than its passing to investors.

Normally when a CEF has a high expense ratio the first thing that comes to mind is leverage. A lot of CEFs use leverage to get ahead and that leverage costs money since they have to borrow and pay interest on it. At first I thought this fund must be using some sort of leverage and its high expense ratio must be in support of that but I didn't see any evidence of that. Also, if it was using leverage it would have a much higher distribution yield than 4.9% when municipal bonds yield close to 6% and this fund trades at a 10% discount to its NAV so it should be yielding much higher.

One could say that since this fund is tax-advantaged, its 4.9% yield is probably equivalent of a 5.5% yield you'd get elsewhere considering taxation which is fair but it almost looks like all of that tax advantage (and some more) is taken away by the fund's high expense ratio when you consider it all.

The fund's share price dropped significantly in the last couple years and investors are down close to 40% excluding dividends. Part of this poor performance was caused by the fact that bonds have been in a bear market during this time which still continues today. This could easily reverse if interest rates started dropping but that would also hurt the yield of this fund. This comes with the territory of bond investment where you either win in yield or price but not both.

Having said that, if you are a retiree and looking for relatively safe income that has tax advantages and don't mind the high expense ratio, you might still find things to like about this fund. If you are more aggressive and looking for higher yield, there are probably better funds for you out there.

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