March 20, 2010, 7:47 p.m. EDT
All About Investing in 'Muni' Bonds
Municipal bonds, once the purview of the belt-and-suspenders crowd, have gotten a lot more intriguing in the past couple of years.
The worst of the financial crisis has passed, but much of the investment world's angst has been transferred to the government debt markets. Exotic places like Greece and Dubai are facing debt difficulties, but such problems also have become more acute closer to home.
California faces a budget mess. New York is romping through now familiar fiscal follies. Rising pension costs from Phoenix to Pittsburgh are making government books tougher to balance. It all raises the question: Are municipal bonds still a safe, shrewd investment?
Short answer: Yes.
Longer answer: But they aren't the no-brainers they used to be.
"Things have changed, and we really have to do far more due dilligence on issuers than we did in the past," says Chris Walters, executive vice president at CitizensTrust, the wealth-management division of Citizens Business Bank in Pasadena, Calif. "In the old days, everyone was pretty much an investment-grade entity and [general obligation] bonds paid a lot lower yield. That's not the case anymore; everything's gotten more challenging from a risk-management perspective."
California, Detroit Borrowing
Despite the challenge, investors have continued to gobble up municipal-bond offerings. California recently sold $2.5 billion in muni bonds -- $500 million more than it expected to sell. This comes less than a year after the Golden State found itself issuing IOUs in lieu of checks when the state went through one of its periodic budget meltdowns. Fiscally challenged Detroit managed to sell $250 million in bonds this month, even though it hasn't managed to pull together its finances in a timely manner in the past few years.Investors are being attracted by higher-than-usual yields. California was paying 5.7% on bonds maturing in 2036. Detroit's bonds maturing in 2035 yielded 5.35%. Treasurys expiring in 2040 yield 4.64%, according to Ryan ALM, a market-data firm. Usually, municipal bonds sport yields lower than comparable Treasurys, but things are less-than-usual these days.
One thing that hasn't changed for munis is their tax advantage over Treasurys and other taxable bonds. Interest isn't taxed at the federal level and many states and localities don't tax that income, either.
Investors also believe that despite the nasty headlines, municipal bonds remain sound investments. In the case of California, investors probably see it as the quintessential state that is Too Big To Fail.
That echoes the view of Greece (Germany will step up) and even Dubai World, where the neighboring Emirate of Abu Dhabi has taken steps to assure investors. "The federal government won't let California default any more than the European Union will let Greece default," says Mr. Walters. "And California is far more important to the U.S. than Greece is to the EU."
With the environment shifting, muni-minded investors should consider tweaking their approach. While the last big muni default took place in 1994 when Orange County blew up, smaller municipalities have since failed, including Vallejo, Calif., in 2008.
The muni-bond standard strategy is to "ladder" various munis across, say, 10 years (though a ladder can stretch out even further or be shorter). But that can be a costly endeavor. Often, it's much easier to use funds to build diversification.
Closed-end funds are a popular approach. These funds are available at both the national and state level. California, New York and New Jersey residents have a plethora of such funds to choose from, underscoring their heavy use of the muni-bond markets.
Most bond investors, especially in the muni space, are focused on income, or yield, and many funds, especially in riskier jurisdictions, have handsome yields. But it's important to bear in mind that higher yields are signaling investor concern. No free lunches in the marketplace!
Among state funds, the BlackRock California Municipal Income fund /quotes/zigman/288690/quotes/nls/bfzBFZ+0.80% (BFZ) is currently yielding 7.1%. The Nuveen New York Municipal Value fund /quotes/zigman/236209/quotes/nls/nnyNNY+0.76% (NNY) is yielding 4.4%. In the national fund category, the Pimco Municipal Income fund /quotes/zigman/287029/quotes/nls/pmfPMF+0.12% (PMF) yields 7.4%.
Mutual Funds, Too
Investors also can tap actively managed mutual funds, such as the Nuveen Insured Municipal Bond fund (NMBIX) yielding 4.55% and the shorter-duration focused Oppenheimer Limited Term Municipal Bond fund (OPITX) yielding 4.91%.In the current environment, with risks relatively higher than usual, Kristopher Burak of Rehmann Financial in Lansing, Mich., recommends focusing on shorter-duration investments.
Mr. Walters echoes the careful approach. He says state general-obligation bonds and state education bonds are among the safer issues because they take priority in terms of government spending, even when a budget isn't in place.
A great resource for investors is the Electronic Municipal Market Access Web site, emma.msrb.org. It's run by the Municipal Securities Rulemaking Board, a government agency charged with watching over the muni-bond industry. The site has educational information as well as market data about recent trades.
