The secret may be out.

Municipal closed-end funds are unique and compelling because they give investors the opportunity to buy a basket of municipal bonds at a discount from market value.

The rub is that for the past few months, significant discounts have been hard to find.

The First Trust Advisors index tracking muni closed-end funds is up 31.5% for the year.

The three biggest muni closed-end funds by assets — the ­Nuveen Municipal Value Fund, the Nuveen Insured Municipal Opportunity Fund, and the ­BlackRock MuniYield Insured Fund — in 2009 are up 16%, 21% and 33%, respectively.

Underpinning the rally is the screaming success of municipal bonds themselves. The 40-bond Bond Buyer municipal bond index has catapulted 14% this year.

The strengthening prices of the underlying munis have bolstered the prices of the funds that invest in them.

This explanation is only partially satisfying. Municipal closed-end funds this year have delivered returns well in excess of municipal bonds.

Citing FundData, Stifel ­Nicolaus analyst Alex Reiss wrote in his latest report that higher asset values explain only about two-thirds of the price appreciation in muni closed-end funds this year. While the funds are up 33.8% in 2009, their assets are up only 21.3%.

The remaining outperformance is attributable to narrowing discounts. This is a fancy way of saying investors are willing to pay more for each dollar of assets owned by a closed-end fund.

Many analysts say the eagerness to pay more per dollar for closed-end fund assets, which helped propel the industry for the first three quarters of the year, should no longer be counted on.

Closed-end funds are entities that raise money by selling stock to investors through an initial public offering and then invest that money in assets such as stocks or municipal bonds.

The funds pay monthly dividends to shareholders from the income earned from those investments.

According to the Investment ­Company Institute, the industry consists of 643 funds with $201.15 billion in assets, of which $73.24 billion are in municipal bonds.

What distinguishes a closed-end fund is its ability to employ leverage.

Many closed-end funds borrow money to supplement the capital raised from shareholders. That additional borrowed money is also invested, and can deliver plumper dividends to shareholders willing to stomach the risk of investing in a leveraged fund.

Because the shares trade publicly and cannot be redeemed at net asset value, the value of a closed-end fund often deviates from the value of its assets.

Many closed-end fund investors like to wait until the discount on a fund is wide and then buy at what they consider a fetching price.

The snag in muni closed-end funds now is that few offer wide discounts.

The average discount on municipal closed-end funds has compressed from 12.4% at the beginning of the year to 3.6% today, according to Reiss.

Thomas J. Herzfeld Advisors finds the discounts so unappealing that it does not have a dime invested in municipal closed-end funds. Every penny of the firm’s $423,484 portfolio dedicated to the sector is in cash.

“The bargains in closed-end funds are few and far between,” Herzfeld wrote in its monthly report for November.

The firm believes funds in the sector are expensive in part because the funds have become so popular.

The title of its commentary this month is “Main Street Discovers Closed-End Funds.”

Until a brief pullback last month, closed-end funds have been riding an “uninterrupted wave of popularity” this year, Herzfeld said.

Herzfeld offered what it considers a tell-tale sign the market is near a top — the press is writing about it. More reporters have been calling the firm asking about low-risk, high-discount funds with tax-exempt yields north of 5%. The firm’s response: there aren’t any.

Stifel’s Reiss wrote in his latest report that while the rally this year has been a “welcome relief,” investors should not count on further appreciation from narrowing ­discounts.

Returns on closed-end funds will now be determined by returns from the underlying bonds, he said, not closed-end share appreciation in excess of those returns.

That does not mean there are no closed-end municipal funds worth owning. Reiss still has buy ratings on a number of funds, including the BlackRock MuniYield Insured Fund and the Nuveen Insured Municipal Opportunity Fund. It just means returns in the sector will have to come from dividends and gains in the underlying assets, not from investors in the stock market willing to pay more per dollar for closed-end funds.

“Investors can no longer count on ­capturing extra returns because of discounts contracting,” Jeff Margolin, an analyst with First Trust, wrote in his closed-end fund report for the third quarter. “Investors need to focus on funds and categories where there is still value in a fund’s underlying asset class. ... If the underlying asset class performs well and the NAV moves higher, ultimately the share price should also move higher and investors can still earn a decent total return in their funds.”

Margolin said the yields on municipal closed-end funds remain alluring even without the promise of further contraction in discounts.

The Closed-End Fund Association lists the distribution yields — defined as total cash returned to each share as a percentage of price — for all the muni closed-end funds.

The five biggest leveraged funds sport an average distribution yield of 5.32%, which assuming a 35% tax rate is a taxable-­equivalent yield of 8.18%.

One of the main reasons dividends remain so high even as yields on municipal bonds have plummeted is cheap leverage.

Closed-end funds that opted to utilize leverage now enjoy extraordinarily low ­financing costs. With the Federal Reserve committed to pinning short-term interest rates close to zero, most closed-end funds are paying paltry sums on their short-term debt.

The closed-end funds at Nuveen ­Investments, for instance, are paying 0.41% on their auction-rate preferred shares.

Whatever interest income Nuveen can generate in excess of that is gravy for the shareholders in its leveraged funds.

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