XMPT ETF: Question and Answer

This blog aims to answer common questions about the VanEck CEF Muni Income ETF (XMPT), an ETF that seeks to replicate the S-Network Municipal Bond Closed-End Fund Index, offering investors diversified access to U.S. listed municipal closed-end funds. Using a rules-based approach, XMPT adjusts for average premiums and discounts, providing a transparent, tradable, and cost-effective investment option.

• What is the methodology behind XMPT?
• What factors influence premiums and discounts in closed-end funds?
• What are the underlying closed-end funds’ weighted average historical discounts compared to where discounts currently are?
• When do discounts signal attractive entry points for XMPT investors?
• Given the volatility and dividend cuts in municipal closed-end funds year-to-date, why might now be an opportunity for investors?
• Was XMPT being used as a tax swap opportunity for clients' portfolios?
• How does XMPT fit within a portfolio?
• How can investors buy VanEck ETFs?

What is the methodology behind XMPT?

The VanEck CEF Muni Income ETF (ticker: XMPT or "Exempt") aims to replicate the performance of the S-Network Municipal Bond Closed-End Fund Index (CEFMXTR), which tracks the performance of U.S. listed closed-end funds that invest in U.S. dollar denominated tax-exempt market. The index comprises four muni bond closed-end fund sectors: leveraged and unleveraged investment-grade strategies and leveraged and unleveraged high-yield strategies. It utilizes a weighting methodology based on each fund's total net assets, adjusted for its average premium and discount (difference between the closing price and the net asset value (“NAV”)) over the past 90 days during quarterly rebalances.

Unlike open-end mutual funds or ETFs, the number of shares of a closed-end fund is fixed, which means that the price of the fund is determined by supply and demand in the secondary market. Unlike ETFs and mutual funds, closed-end funds don’t do primary market creations and redemptions to release the pressure of secondary market buying and selling, which, in an ETF helps keep large premiums and/or discounts from occurring. As a result, closed-end funds tend to trade at either a premium or discount to their NAV. XMPT’s index rules overweight exposure to funds trading at wider discounts and away from funds trading at a premium. By incorporating this modified net asset weighting, the index effectively manages the discount exposure for investors, essentially buying discounted assets and selling overpriced ones in a systematic, rules-based manner.

Closed-end funds must meet the following criteria for inclusion:

• Minimum $100 million in assets under management (AUM)
• Minimum monthly trading volume of 250,000 shares in the past six months
• Average daily trading volume exceeding $500,000 per day in the past three months
• Management fee below 1.25%

Approximately 85% of the fund and index are investment-grade, and XMPT distributes dividend payments monthly. By investing in XMPT, the investor gains diversification across underlying closed-end fund assets (muni bonds) and investment strategies, access to prominent active asset managers through a single trade, with the transparency and tradability of an ETF.

What factors influence premiums and discounts in closed-end funds?

The closed structure of these funds causes investor sentiment to be the main driver of discounts to NAV. Factors influencing sentiment include credit events, interest rate policies, headlines, liquidity, and changes in distribution rates.

In the U.S., rising interest rates and distribution cuts have been major concerns for muni closed-end fund investors. Several funds announced dividend cuts in the past year, primarily due to increased borrowing costs for leverage usage and the short-end muni yield curve inversion. Short-term rates (the rate at which the funds typically borrow) are currently higher than the middle part of the curve and only slightly lower than the long end of the curve. This means that borrowing in the short term to buy long-dated bonds is no longer a viable strategy to boost the yield in a given portfolio. Portfolio managers are stuck between adding risk by buying long dated lower-quality bonds or accepting a lower yield.

When funds reduce distributions, discounts typically widen. Although predicting distribution changes could help investors stay ahead, the premium/discount weighting in XMPT's underlying index can capitalize on these dislocations. This approach facilitates buying discounted assets and selling those at premiums, offering a strategic advantage.

What are the underlying closed-end funds’ weighted average historical discounts compared to where discounts currently are?

Since the fund's inception, the average discount of the underlying funds has been -5.05%, with the current discount hovering at around -12.5%. Throughout most of 2021, the underlying funds were at a slight premium, which began to widen out at the beginning of 2022, when the current rate hike cycle began. We have seen discount volatility since then, and we expect this to continue. But we believe investors may benefit from deploying cash into discounts at these levels.

When do discounts signal attractive entry points for XMPT investors?

Potential buying opportunities typically arise when closed-end fund discounts reach the long-term average. However, a particularly attractive total return opportunity has historically emerged when discounts hit or exceed -10%. Out of approximately 3,000 trading days since XMPT's inception in 2011, this has occurred only 109 times, accounting for just over 3% of those days.

Premium/Discount: CEFs Held by XMPT

Source: VanEck. As of 5/15/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities mentioned herein.

Before the pandemic, the discount had approached this magnitude only five times. On average, in the 11 months following a 10% discount, the fund experienced an average cumulative total return of 20%.

Given the volatility and dividend cuts in municipal closed-end funds year-to-date, why might now be an opportunity for investors?

Closed-end funds are inherently volatile, and the current fixed-income environment has made muni closed-end funds even more so. However, volatility seems to have become the new normal for the municipal market over the past five years. In the last year, most of the closed-end funds in the portfolio have cut their dividends, which has helped to widen discounts across the board. It’s also important to note that closed-end funds will boost their dividends when possible. A disciplined allocation approach could be appropriate given the historical returns of investing during wide discounts.

Although the current rate hike cycle may not be over, it could conclude before the year's end. Historically, negative performance years for muni closed-end funds have been followed by strong recovery years, which could occur in 2023.

Was XMPT being used as a tax swap opportunity for clients' portfolios?

We believe that XMPT's diversified, discount-weighted approach offers a smarter investment strategy compared to trying to pick individual winners and avoid losers. Regarding tax swaps, muni-focused ETFs, including XMPT, were likely used as tax-loss harvesting tools throughout 2022, capturing at least a portion of the related fund flows.

How does XMPT fit within a portfolio?

XMPT serves as a long-term strategic allocation for investors seeking a high level of tax-exempt income while diversifying away from traditional high-yield (below investment grade) exposures. We believe it complements, rather than replaces, below investment-grade muni bonds or muni bond funds.

XMPT offers three key benefits:

• High level of tax-exempt income
• Diversification by asset, strategy, and manager
• Opportunity to capitalize on inefficiencies in the closed-end fund market, enabling the purchase of assets at discounts to NAV

Source: VanEck. As of 3/31/2023.

Returns less than one year are not annualized.

The performance data quoted represents past performance. Past performance is not a guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Performance may be lower or higher than performance data quoted. Please call 800.826.2333 or visit vaneck.com for performance current to the most recent month ended.

The "Net Asset Value" (NAV) of a Fund is determined at the close of each business day, and represents the dollar value of one share of the fund; it is calculated by taking the total assets of the fund, subtracting total liabilities, and dividing by the total number of shares outstanding. The NAV is not necessarily the same as the ETF 's intraday trading value. Investors should not expect to buy or sell shares at NAV.

How can investors buy VanEck ETFs?

Learn more here.

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