Summary
- ETX offers an attractive lower-duration Municipal option for the current market environment of flat yield curves and tight credit spreads.
- The fund has historically outperformed the broader tax-exempt Muni CEF sector.
- As a 2028 term fund, ETC offers the potential to deliver significant upside in case the manager offers investors an exit at the NAV.
- ETX trades at a 4.16% yield and 6.6% discount.
This article was first released to Systematic Income subscribers and free trials on Feb. 17.
In this article we highlight the Eaton Vance Municipal Income 2028 Term Trust ( ETX ) - a tax-exempt Muni CEF, trading at a 4.16% yield and a 6.6% discount.
ETX can be an attractive choice for income investors for a few reasons - its lower beta, its good fit for the current market environment and its term structure. The fund's lower beta comes from its slightly below-median leverage level and shorter-duration while the term structure also contributes to a lower volatility profile as well as potential upside from discount amortization in case of termination.
A Fit For Key Market Dynamics
In this section we touch on why ETX is a decent fit for the current fixed-income market environment.
As we have highlighted previously, the two key market dynamics we are watching at the moment are inverted / flat yield curves and relatively tight credit spreads.
The chart below shows the yield curves of the Treasury, tax-exempt and taxable Muni markets. The Treasury curve is the only one that is inverted; however, the other two are relatively flat for their own history.
We can see this better for the tax-exempt market in the following chart which plots different tax-exempt yield curve levels, showing that outside of the 10s20s (i.e. 20Y tax-exempt Muni bond yield less 10Y tax-exempt Muni bond yield) the curve is unusually flat. What this means is that taking on more duration risk i.e. buying longer-dated bonds is not particularly well compensated right now as it has tended to be historically. This makes shorter-duration bonds somewhat more attractive.
The second key dynamic that is top of mind for us is the relatively tight level of credit spreads. The chart below shows that high-yield bond credit spreads have tightened to 4.18% off their 5.99% peak in 2022. In 2022 we highlighted strong reasons to buy high-yield corporate bonds as credit spreads moved swiftly north of 5% (and overall yields north of 9%) however at current level of yields and credit spreads, riskier credit assets are much less appealing as a destination for new capital.
The key takeaway here is that a fund like ETX which focuses on shorter-duration and higher-quality bonds is a good fit for the current market environment.
Fund Snapshot
What's particularly notable about EXT in the overall Muni CEF sector is its lower duration profile as we can see below. The fund boasts a duration of around 4 which is about half the typical Muni CEF and a quarter of some of the very long duration options such as NMCO and others.
The fund has a similar allocation to the broader tax-exempt sector with a slightly lower AAA allocation and a higher AA allocation. The fund's leverage is slightly below the sector median at 33% versus 38%.
Fund Overview
The key question from a forward performance profile is whether the fund will actually terminate on its expected termination date in 2028. If ETX were a Nuveen fund there would be little need for discussion since Nuveen has been terminating (or offering investors the economically identical exit at the NAV via a tender offer) like clockwork on its own large population of term CEFs.
Eaton Vance does not have a similarly large term CEF population so it lacks the track record of Nuveen. Eaton Vance did terminate the Eaton Vance High Income 2021 Target Term Trust ( EHT ) however target term CEFs are more likely to terminate since their assets typically match the termination date and the fund simply runs out of assets.
A non-target term fund like ETX is more likely to be converted into a perpetual CEF since all of its assets will still be around by the time the termination date rolls around. CEF shareholders are also a curious bunch and often vote against their interest, guided by a kind of loss aversion, being happier to keep the fund they hold rather than gain from significant upside via discount amortization to zero.
In short, it's difficult to have a lot of confidence in the fund's discount moving to zero however we can't rule it out. As it is, the fund's current discount of 6.6% offers an asymmetrically positive risk/reward. If the fund fails to give investors an exit at the NAV (via termination or a tender offer) its discount is likely to simply widen to the sector average of 7.6%. And if the fund does give investors an exit at the NAV then its discount will tighten from 6.6% to zero. A downside of 1% and upside of 6.6% is not a bad deal. The risk is that the discount widens past the sector average in case of perpetual conversion and that's possible in light of the fund's below sector-average current yield of 4.2% versus 4.6% however that should be mitigated by its above-average historic return.
If we look at the fund's discount profile we see that it tended to trade at a significantly tighter discount than the sector average but has recently converged with the sector average. This convergence offers an attractive entry point in our view.
Historically, ETX has delivered an above sector-average total NAV return. Its price has also held in much better over the past year, owing both to its lower duration as well as its term structure, which provides a stronger discount anchor.
ETX cut its distribution once this year and its ongoing distribution coverage picture doesn't look amazing. However, this is pretty much par for the course in the tax-exempt CEF space where net income has fallen due to rising leverage costs. If anything, by boasting a lower level of leverage, ETX has experienced a lower drop in net income, all else equal.
Takeaways
ETX offers an attractive income option for investors owing to its term structure, good valuation entry point, and a good fit for the current market environment.
If municipal yields continue to move lower, the case for ETX would be even stronger. The lower yields go, the less upside there is to holding longer-duration assets and the more attractive lower-duration assets are such as those held by ETX.
For further details see:
ETX: An Attractive Lower Beta Municipal CEF