BlackRock has raised more than $1 billion for a closed-end fund devoted to Build America Bonds, creating the largest public vehicle offering investors exposure to the new class of taxable municipal debt.
In an underwriting led by Wells Fargo Securities, the BlackRock Build America Bond Trust sold 50.8 million shares last week at $20 per share.
The fund collected $1.02 billion, or $967.3 million after expenses.
The underwriters expect to sell the shares to investors Tuesday. After that, the underwriters have the option of buying additional shares that could produce total after-cost proceeds of as much as $1.11 billion.
This fund, which dwarfs other public vehicles devoted to BABs, plans to invest mainly in investment-grade Build America Bonds — a type of municipal debt created under the American Recovery and Reinvestment Act in February of last year.
The program authorizes municipalities to forgo the customary tax exemption on their debt and instead float taxable bonds, collecting a federal subsidy equal to 35% of their interest costs.
State and local governments have sold $129.79 billion of BABs since they first came to market in April 2009.
BlackRock believes "there could be an opportunity to capitalize on the market for BABs by investing in taxable municipal issues at attractive market yields relative to the yields on equivalently rated corporate bonds," according to the trust's prospectus.
The average BAB has a maturity of about 29 years and yields 5.65%, according to a Wells Fargo index tracking the sector.
BABs offer "a potential yield advantage and lower default risk than similarly rated corporate bonds," Frank Porcelli, head of U.S. retail at BlackRock, said in a statement.
The fund will be managed by BlackRock's municipal team, which is led by Peter Hayes.
With 27 portfolio managers and 12 analysts, the team manages $108.5 billion in munis, including 61 closed-end funds with $22.5 billion in assets.
“It just shows the desire for yield,” Hayes said. “Investors are becoming more comfortable with the fact that interest rates probably stay low for an extended period of time. ... There’s some willingness to extend out the yield curve.”
The new BlackRock fund easily eclipsed the prior BAB leader, which Nuveen Investments launched in April. Nuveen's closed-end fund manages $605.6 million of BABs.
The next-biggest vehicle is an Invesco PowerShares exchange-traded fund with $533 million in assets. A second BAB ETF, managed by State Street Global Advisors, holds $22.9 million.
A Canadian BAB mutual fund subadvised by Nuveen Investments manages $31.7 million. An Eaton Vance BAB mutual fund manages $27.2 million.
What distinguishes a closed-end fund from a mutual or exchange-traded fund is the ability to employ leverage.
Many municipal CEFs borrow money in excess of the cash raised through their initial public offerings. That borrowed money is then used to purchase additional municipal bonds.
Closed-end funds can use leverage to goose their income as long as the yields on municipal bonds are higher than the interest costs on borrowed money.
The BlackRock trust is considering a number of leverage mechanisms, including borrowing from a bank, investing in reverse repurchase agreements, or issuing preferred shares. The trust also devoted quite a bit of ink in its 197-page prospectus to exploring a tender-option bond structure.
With borrowing costs low and the municipal yield curve steep, state and local government closed-end funds are in an ideal environment.
Most closed-end funds' borrowing costs are tethered to the London Interbank Offered Rate, which is less than 0.3%. Buying a long-term municipal bond yielding 5.65% using borrowed money costing 0.3% has powerfully amplified CEFs' monthly dividends at a time when yields of any kind are difficult to find.
Nuveen's BAB closed-end fund, for example, yields 6.9%. By contrast, the unleveraged Invesco BABs ETF yields 5.5%, based on the latest dividend.
“The curve is very steep, so the use of leverage is very beneficial in such an environment,” Hayes said.
The municipal closed-end fund sector has returned 15.8% this year, and 65.6% since the end of 2008, according to a First Trust Advisors index.
"The IPOs of closed-end funds have been well received," said Cecilia Gondor, executive vice president of Thomas J. Herzfeld Advisors. "It just looks like investors are enthusiastic about funds that offer yield."
The closed-end fund industry manages $80 billion of tax-exempt state and local government debt, according to the Investment Company Institute.
