A fund’s use of inverse floaters creates effective leverage.

Municipal bond securities are subject to interest rate risk (as interest rates rise bond prices usually fall) call risk reinvestment risk issuer credit risk and tax risk. Nuveen strategies for mitigating TOB-specific riskįund shares are subject to investment and market risks, including the possible loss of principal invested. It is not possible for individuals to invest directly in securities issued by TOB trusts. Nuveen has several processes, procedures and people in place to try to mitigate these risks for fund shareholders. If that happens, the fund may choose to sell other assets to buy back the trust’s floating rate security, which could negatively affect fund performance, or liquidate the trust assets. Most of these risks lead to terminating a TOB trust. There are certain risks associated specifically with TOBs, however. Leverage has a multiplying effect - it magnifies returns, both positive and negative, and it increases fund risk by magnifying the volatility of returns. Things to consider about Tender Option Bondsįor a fund shareholder, TOB inverse floaters offer the fund’s portfolio manager more flexibility in managing portfolio investments, as well as increased income and return potential from increased leverage.

The trust is created based on the expectation that the borrowing rate is less than the yield of the underlying bonds the trust purchases. The following diagram shows a hypothetical Tender Option Bond example, using a $50 million group of bonds held by a fund, and 4:1 gearing (the ratio of the floater value to the inverse floater value).

The holder of an inverse floater bears substantially all of the underlying bond’s downside risk, and also benefits disproportionately from any appreciation of the underlying bond’s value.

The relative fraction between the value of the floater and the value of the inverse floater is termed “gearing,” which relates to the amount of leverage inherent in the TOB structure.

The inverse floater value usually represents less than half the value of the underlying bonds.

Inverse floaters receive the interest equal to the interest from the underlying bonds, less the interest paid to floating rate security holders (and less certain expenses).

Owner (typically a fund) has “full” exposure to each underlying bond’s market opportunity and risk, creating a leveraged investment.

Interest paid on floaters is usually a short-term weekly rateĢ. Residual interest securities or “inverse floaters”.

Sold predominately to money market funds the trust pays a liquidity provider to guarantee weekly liquidity.

Tender Option Bond trusts issue two securitiesġ. The expectation is that the purchased long-term bonds will yield more than the borrowing rate paid on short-term floating rate securities issued by the trust. Using inverse floaters effectively enables a fund to borrow (mainly from money market funds or other cash-like investors) and then use the money to purchase additional long-term, fixed-rate bonds for the fund’s portfolio. Only some bonds will qualify or make business sense for this structure, generally bonds that satisfy money market fund investment requirements, i.e., SEC Rule 2a-7. The other security - the inverse floating rate security 2 - is retained by the Nuveen fund. One of the securities - the floating rate security 1 - is typically sold to a money market fund that is only permitted to buy investments of high quality and short maturity.

Nuveen funds use Tender Option Bonds residual interests for portfolio management goals such as creating additional opportunistic exposure to a certain bond sector or part of the municipal bond yield curve, and/or to create long-term, strategic leverage exposure for the overall fund.Ī Tender Option Bond (TOB) is the common phrase for a security issued by a special purpose trust (a Tender Option Bond Trust) into which bonds are deposited, and which then issues two types of securities. Tender Option Bonds are special purpose trust investments that create leverage by borrowing primarily from money market funds or other cash-like investors to invest in high quality municipal bonds.

Tender manager definition