NEW YORK: The riskiest part of the US$4 trillion (RM16.63 trillion) municipal bond market may see demand fade, as the largest fund devoted to buying that debt closes its doors to new investors, according to Citigroup Inc strategists.

       Nuveen’s plan to limit new money in its high-yield muni fund signals to investors that the market for riskier tax-free bonds may be overheating, strategists led by Vikram Rai wrote this week, in a report that doesn’t mention the asset manager by name.

       In addition to the signalling effect, Nuveen’s fund accounts for almost a fifth of the assets under management by high-yield muni asset managers, according to Citigroup.

       Even if existing holders keep adding money, and new investors hand their dollars over to other firms, the fund is big enough to have an impact on the overall market as its demand slows.

       “You can expect spreads to cheapen because one, people will buy less and secondly the largest mission fund manager will also buy less,” Rai said in an interview.

       The strategists estimate that the Nuveen fund’s demand for new securities will drop by about 50%.

       But it’s unusual for muni funds to close their doors to new investors, so it’s hard to know what the net decline will be for demand overall in the market as at least some investors pour money into other funds, they wrote.

       In addition to high-yield municipal bonds getting weaker relative to treasuries, valuations will likely fall overall, Rai wrote.

       Any declines would come after the securities lost 0.2% in August on a total return basis, the first monthly decline since February, according to a Bloomberg index.

       The debt has still gained 7.2% this year.

       Nuveen said last month that its High Yield Municipal Bond Fund, run by John Miller, planned to close to new investors at the end of September. It has returned around 15% over the past year, better than all but 2% of its peers, according to data compiled by Bloomberg.

       Junk and unrated munis can fund a range of issuers.

       These include airline-linked projects and convention centres.

       Investors have poured nearly US$18bil (RM74.84bil) into funds buying these securities this year, as an improving economy and federal bailouts for state and local governments have made many fund buyers more willing to take risk.

       Meanwhile, there are only so many opportunities to buy high-yield muni bonds now, Citigroup strategists wrote.

       They noted that “demand far exceeds supply.”

       Buying investment-grade securities would depress returns for these funds.

       Nuveen’s move came after Invesco in May said it was closing its high-yield muni fund to new investors.

       Nuveen investment and product teams will closely monitor market conditions and other fund-specific factors and will actively look to change the direction of funds when it is deemed to be in the best interest of shareholders, the company said. ― Bloomberg