RMMZ - RMMZ: Interesting Dual Muni Bond Strategy Earns A Sell Rating

2024-01-01 09:00:00 ET

Summary

• RiverNorth Managed Duration Municipal Income Fund II combines two investment strategies in its portfolio.
• RMMZ has $146.6m in common assets and $231m in total AUM, with a yield of 6.9%.
• The fund implements a managed duration strategy and shifts allocation between the two strategies based on market conditions.
• After comparing RMMZ against other RiverNorth and three competing CEFs from other managers, the results yielded a Sell rating for RMMZ.

Introduction

RiverNorth has five municipal bond CEFs, operating under three distinct strategies. This article will review the newest one, the RiverNorth Managed Duration Municipal Income Fund II ( RMMZ ). What is different here from most Municipal bond CEFs is each RiverNorth CEF combines two investment strategies. After reviewing this CEF, I compare its results against all the other RiverNorth Muni CEFs and then three Muni CEFs with similar leverage and durations. With both groups having better funds available, RMMZ gets a Sell rating. The high fees are reason enough to avoid these CEFs from RiverNorth.

RiverNorth Managed Duration Municipal Income Fund II review

Seeking Alpha provides this description:

The Fund’s primary investment objective is current income exempt from regular U.S. federal income taxes. The Fund’s secondary investment objective is total return. The Fund seeks to achieve its investment objectives by investing, directly or indirectly, at least 80% of its Managed Assets in municipal bonds, the interest on which is, in the opinion of bond counsel to the issuers, generally excludable from gross income for regular U.S. federal income tax purposes, except that the interest may be includable in taxable income for purposes of the Federal alternative minimum tax. RMMZ started in February 2022. Benchmark: Bloomberg US Municipal Index

RMMZ has $146.6m in Common assets and $231 on Total AUM. RMMZ doesn't list fees on their website but both Fidelity and CEFConnect show 429bps in fees, of which the managers get 140bps; leverage cost is about 200bps. According to the Annual Report , fees charged by held CEFs are additional. Leverage is around 40%. The yield is 6.9%.

The managers of RMMZ provided this description of their two-prong investment strategy as outlined on the CEF’s homepage.

RiverNorth allocates the Fund's managed assets between two principal strategies: Tactical Municipal Closed-End Fund Strategy (managed by RiverNorth) and Municipal Bond Income Strategy (managed by MacKay Shields).

RiverNorth Tactical Municipal Closed-End Fund Strategy

• Seeks to generate returns through investments in investment companies primarily invested in municipal securities
• Seeks to derive value from the discount and premium spreads associated with closed-end funds
• Typically invests in municipal closed end funds (CEFs), and exchange traded funds (ETFs)

MacKay Shields Municipal Bond Income Strategy

• Seeks to generate attractive risk-adjusted tax free income and total return through investments in municipal bonds
• Targeted sources of alpha include security selection, sector rotation, yield curve positioning and duration management
• Primarily invests in investment grade municipal debt securities with the ability to invest in any credit quality, including securities that are rated below investment grade

Source: rivernorth.com/rmmz

The Tactical CEF strategy has a target range of 25-65%; the Bond Income strategy 35-65% range. RiverNorth believes that complementary investment strategies may allow the Fund to opportunistically generate returns during varying market conditions. The Fund also implements a managed duration strategy which targets a weighted average effective duration within three years of the weighted average effective duration of the Bloomberg US Municipal Index (excluding the effects of leverage). At the end of November, the index had a duration of 6.18 years. The Prospectus goes into detail on each strategy. The fund shifts allocation between the two based on varying market conditions, represented by the following charts.

I could not find if RiverNorth defined what constitutes each environment. Please note that the fund was setup with a 15year lifespan, which the fund’s Board has some discretion over as explained here:

• Beginning one year before February 16, 2037 (the "Termination Date"), the Fund may begin to liquidate all or a portion of the Fund's portfolio. At the discretion of the Board of Directors ("Board"), the Termination Date may be extended (i) once for up to one year, and (ii) once for up to an additional six months; or
• Within twelve months prior to the Termination Date, the Fund may conduct a tender offer to purchase 100% of the then outstanding shares. Following the completion of the tender offer, the Fund must have at least $100 million of net assets. The Board may then eliminate the Termination Date and convert the Fund to a perpetual structure upon the affirmative vote of a majority of the Board.

Source: rivernorth.com rmmz

Holdings review

This is how the allocation between the two strategies have moved over the past year.

RiverNorth is playing it close-to-the-vest on holdings, with the last reported list from 9/30/23 and only containing the Top 10 holdings, which differ by source.

The estimated unhedged duration was 10.5 years and the estimated hedged duration 7.9 years as of the end of September.

Distribution review

While it appears missing, the April'23 payout was the same as the previous/next month levels. $.0971. RMMZ has a managed distribution policy like other RiverNorth CEFs, with a current rate set at 6.75%, set each year based on NAV. As a result, about 75% of the 2023 payouts came from ROC, with a large percent in 2022 also from ROC. Based on fund policy, investors must “opt out” of the automatic dividend reinvestment policy.

Price Vs NAV review

The discount looks attractive at -10.6%, but late last year, the smallest was just under 6%, not much room for improvement but temping for discount shrinkage investors.

Comparing funds

RiverNorth’s other four Municipal Bond CEFs used in the first comparison are:

• RiverNorth Managed Duration Municipal Income Fund ( RMM )
• RiverNorth Opportunistic Municipal Income Fund ( RMI )
• RiverNorth Flexible Municipal Income Fund ( RFM )
• RiverNorth Flexible Municipal Income Fund II ( RFMZ )

The main learning from this comparison set is the CEF From MainStay MacKay is the top performer in both data sets. If that is providing the better results to the RiverNorth CEFs, owning MMD plus a higher-yielding Muni CEF should be considered.

Portfolio strategy

With the potential for higher tax rates on income if the current brackets are allowed to expire by the next administration and the apparent peak in interest rates, Municipal bond funds can be attractive to two types of investors.

• For investors in the top most brackets, the after-tax yield should be superior to investment-grade corporates of the same maturity.
• Most Municipal bond funds have long durations, which should outperform shorter duration funds with similar credit ratings.

As the above chart indicates, Municipal bond CEFs are at historical discount levels. The RiverNorth Municipal Closed-End Fund Index is an equal weighted index of 50 national municipal closed-end funds. The next chart shows the CEFs that make up the index bottomed recently, with a rally through the end of November, when the chart was compiled.

Final thoughts

The easiest part here is giving RMMZ a Sell rating based on CAGR and its fees. Of the other CEFs it was compared to, it placed next to last. With Municipal CEFs trading at historical discounts, owning to watch that price-to-NAV narrow would lead investors to pick Municipal CEFs over ETFs or CEF without leverage.

The more interesting question this analysis raises is whether buying the best performer, MMD, still makes sense going forward as it sports a lower yield than most and by far, the smallest discount. That said, it has a history of trading at premium. While MMD doesn't appear to use ROC in its payouts, they have cut it every quarter in 2023. Lucky for readers, other Seeking Alpha contributors have recently covered that investment choice.

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