World’s Top Junk-Muni Fund Is Loaded With a Rarely Traded Stock

The biggest holding in the world’s biggest high-yield municipal bond fund isn’t a municipal bond.

(Bloomberg) — The biggest holding in the world’s biggest high-yield municipal bond fund isn’t a municipal bond.

It’s a $1.5 billion stake in shares of Energy Harbor Corp., a thinly traded power company that’s not listed on any US stock exchange. The Nuveen High Yield Municipal Bond Fund — like many others run by the investment giant — received the stock three years ago after the company’s precursor, FirstEnergy Solutions, restructured its debts in bankruptcy.

It hasn’t been a bad investment. In fact, the shares have surged so much that it’s creating a dilemma for Nuveen — and posing a little-known risk to its investors.

That rally, coupled with an exodus of cash last year as bonds were hit by the deepest losses in decades, has left about 8% of the $18 billion high-yield fund invested in the stock. Energy Harbor shares have also become the single biggest position in 14 of Nuveen’s other muni-bond funds. All told, Nuveen owns 38 million, or 40%, of Energy Harbor’s shares, a stock that on some days isn’t even traded at all.

The concentration casts doubt on whether any of the funds could unload the shares without dragging down the price, raising the specter of a hit that would ripple across Nuveen’s holdings if investors yanked out their cash. That’s a risk not typically associated with vehicles focused on municipal bonds, a mainstay of buy-and-hold investors.

“I don’t think financial advisers and retail investors who own Nuveen’s high yield muni fund are aware of the equity risk,” said Ryan Paylor, a portfolio manager at Thomas J. Herzfeld Advisors.

“If they start redeeming, it’s going to be a problem,” he said. “It’s probably going to be difficult for them to get out of that position without really pushing the price down.” 

Nuveen, a unit of Teachers Insurance and Annuity Association of America that oversees more than $1 trillion in assets, is confident that its open-end funds will be able to meet shareholder redemptions, a Nuveen spokesperson said in a statement. The funds, which disclose their holdings on Nuveen’s website, successfully navigated such a pullback last year, when bonds were hammered by losses, and the market has since largely stabilized. 

Even so, the stock holdings have created some difficulties. In December, Nuveen disclosed that the high-yield fund’s holdings of certain unnamed “illiquid” assets had breached a 15% limit set by the Securities and Exchange Commission, which requires funds to detail plans for getting back below the threshold.

The stake also led Nuveen to backtrack on share buybacks it proposed as part of a plan to extend the life of two closed-end muni funds scheduled to wind down this year. Shareholders approved the repurchases, which would have given investors who wanted to a chance to exit. 

But Nuveen scuttled the plans last month, saying it likely couldn’t sell the funds’ illiquid securities to raise the needed cash. On Wednesday, Nuveen identified the Energy Harbor shares as the illiquid securities, adding that, due to the firm’s status as a substantial minority shareholder and board member, federal laws prevent the funds from selling them “except under limited conditions.” 

It’s reverting to the originally scheduled wind-downs, albeit with an approach that delays the full payouts until the stock can be sold. Nuveen said it couldn’t predict when that will happen. At the end of last year, the two funds held over a million Energy Harbor shares. 

‘Shocking to Me’

Jerry Paul, a senior vice president at Icon Advisers, said he was surprised the funds had such a big position in illiquid securities so close to their scheduled wind downs.

“That was shocking to me,” said Paul, whose firm holds shares of both closed-end funds. “If you’re mom and pop and you thought that you were gonna get your money back and get a chance to reinvest it, that’s got to be pretty disappointing.”

Unlike those two, Nuveen’s high-yield fund is an open-end one, meaning that it must stand ready to meet shareholder redemptions on a daily basis. It’s the largest of its kind, and it swelled under manager John Miller as its bets on the riskiest municipal bonds typically delivered big returns.

It was such an investment that resulted in its stake in Energy Harbor. It initially bought municipal bonds issued for FirstEnergy, which owned and operated nuclear plants in Ohio and Pennsylvania. 

In 2018, the company collapsed into bankruptcy. Nuveen’s high-yield fund held FirstEnergy debt valued at about $190 million at the time, accounting for about 1.2% of its net assets. When the company emerged from the restructuring as Energy Harbor two years later, the high-yield fund and others at Nuveen that also held such debt received stock in the company.

Stock Price Triples

The shares have been a boon for the funds. Its price has surged to $77 from $25 in March 2020, supported by strong demand for energy, rising prices and tax credits extended by President Joe Biden’s Inflation Reduction Act. 

That rally came as the Federal Reserve’s aggressive interest-rate hikes were hammering bonds. As the losses piled up, investors pulled about $2.8 billion out of the fund during the first three quarters of 2022, according to SEC filings. The combination of the two forces caused the Energy Harbor stake to account for a growing share of the high-yield fund’s assets. 

Last year wasn’t the first time the high-yield fund dealt with a retreat by investors. In March 2020, when the onset of the pandemic caused panic in financial markets, investors withdrew sharply from the fund, threatening to force it to sell assets into a fire sale. But Nuveen’s parent, TIAA, helped to head that off: It purchased $1.1 billion of the fund’s shares, extending it a lifeline.

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