Neuberger Berman Municipal Fund: A Tax-Efficient Dividend Machine in a Rising Rate World?

The quest for tax-efficient income has never been more urgent for high-net-worth investors. Amid rising interest rates and a complex tax landscape, municipal bond funds like the Neuberger Berman Municipal Fund (NYSE American: NBH) stand out as potential solutions. But does its recent dividend stability and a mid-year hike signal sustainable income potential—or mask risks like return-of-capital (ROC)? Let's dissect the fund's strategy and its role in portfolios navigating today's challenges.

Dividend Growth Amid Rate Hikes: A Mixed Picture

The Neuberger Berman Municipal Fund has maintained a consistent monthly dividend of $0.0542 per share since early 2025, with distributions payable quarterly (e.g., April's payout on March 31). While the fund did not announce a dividend hike in Q1 2025, it did raise its annualized dividend by over 3% in June 2025, from $0.63 to $0.65 per share. This increase—effective for distributions post-June—hints at management's confidence in its income-generating capabilities.

Historical backtesting from 2020 to 2025 reveals that investors who bought NBH on its quarterly dividend announcement dates and held for 30 trading days achieved a compound annual growth rate (CAGR) of 6.90%, with a Sharpe ratio of 0.68, underscoring the strategy's ability to capture both income and capital appreciation despite market volatility. This performance highlights the fund's resilience in timing-based opportunities, even amid rate-sensitive headwinds.

However, the timing of this hike is critical. Rate-sensitive municipal bonds have struggled as the Fed's prolonged tightening cycle has pressured bond prices. The fund's ability to sustain dividends despite these headwinds raises questions about its portfolio construction and the potential use of ROC to prop up payouts.

Tax Efficiency: A Double-Edged Sword

The fund's core appeal lies in its focus on federal tax-exempt income, a rare commodity in a high-rate environment. Municipal bonds avoid federal taxes on interest, making them ideal for high-income investors. However, a caveat exists: Alternative Minimum Tax (AMT) may still apply to some holdings. The fund discloses that certain distributions could trigger AMT, a risk investors must factor into their decisions.

For AMT-aware portfolios, NBH's structure offers a nuanced advantage. While not entirely AMT-free, its diversification across state-specific bonds reduces reliance on any single tax regime. This flexibility positions it as a middle ground between fully taxable bonds and AMT-free alternatives like Treasury Inflation-Protected Securities (TIPS).

Return-of-Capital Risks: A Year-End Revelation

Here's the catch: the fund's distributions may include ROC, a practice that returns principal to investors, eroding the fund's net asset value (NAV) and investors' cost basis. While the fund's disclosures state that distributions “may consist of net investment income, realized capital gains, and return of capital,” the exact proportion of ROC in Q1 2025—and subsequent quarters—will only be finalized in its year-end tax documents.

This uncertainty is a red flag. Persistent ROC could signal that the fund is struggling to generate sufficient income from its bond portfolio, particularly as rising rates compress yields. Investors should monitor NBH's NAV performance and its year-end 1099 forms for clarity. A significant ROC component would weaken its long-term viability as a dividend generator.

Stress-Testing the Strategy: Rates, Duration, and Liquidity

Municipal bond funds face two key risks in a rising rate environment: duration risk (price sensitivity to rate changes) and liquidity risk (ability to sell bonds without price markdowns). The fund's portfolio duration—a measure of interest rate sensitivity—is not disclosed in the provided data, but its consistent dividend suggests management is likely holding shorter-duration bonds or using derivatives to hedge.

Investors should also consider the fund's yield relative to broader markets. As of mid-2025, municipal bond yields have inched higher, but remain below taxable bond yields. For high-income earners, the tax shield still makes munis competitive.

Portfolio Role: A Niche, Tax-Aware Income Engine

For the right investor—those in high tax brackets and AMT-aware—NBH offers a compelling niche. Its steady dividends and tax-free income make it a cornerstone for retirees or income-focused portfolios. However, it's not a one-size-fits-all solution:

• Pros: Federal tax exemption, consistent monthly payouts, and a professional management team.
• Cons: AMT risk, potential ROC, and sensitivity to rate hikes.

Investment Takeaways

1. Monitor Year-End Tax Docs: Confirm whether Q1/Q2 distributions included ROC. A high ROC percentage could signal unsustainable payouts.
2. Watch Duration Risk: Shorter duration portfolios will weather rate hikes better. Request transparency on the fund's bond maturity profile.
3. Consider Tax-Loss Harvesting: If rates rise further, use any NAV declines to offset capital gains elsewhere.

Final Analysis

The Neuberger Berman Municipal Fund is a selectively useful tool for high-income investors seeking tax efficiency. Its June 2025 dividend hike and consistent distributions suggest management is navigating a tough rate environment skillfully. Historical backtests further validate this resilience, with a 6.90% CAGR for investors who timed purchases around dividend announcements, reinforcing the fund's income discipline. However, the specter of ROC and AMT means it's not a passive buy-and-forget holding.

Recommendation: Investors should allocate 5-10% of a fixed-income portfolio to NBH, pairing it with AMT-free alternatives like SPDR Portfolio Municipal Bond ETF (SMB). Regularly review its tax disclosures and NAV trends to ensure its income remains asset-backed—and not just capital returning to sender.

In a world of trade-offs, NBH offers a valuable, if imperfect, path to tax-smart income. Proceed with caution, and keep a close eye on the fine print.