Municipal bond funds attracting many investors
The focus in tax-advantaged investments in a tumultuous market has turned to municipal bonds.
The traditional benefit to investors of the $2.6 trillion muni market is interest income exempt from federal tax and, in many cases, from state and local taxes, though municipals issued for certain purposes may not be tax exempt.
As financial markets gyrate on talk of recession, interest rate cuts, tax cuts and troubles of bond insurers, municipal bonds have become much cheaper to buy and their yields more like taxable bonds.
“Almost anyone in the 28 percent tax bracket or above should be considering municipal bonds, and we advise they stay with short- to intermediate-term, high-quality bonds,” said Harold Evensky, certified financial planner with Evensky & Katz in Coral Gables, Fla. “There’s a good deal of risk and very little reward for extending bond maturities out beyond 10 years.”
Although muni bonds historically offer about 80 percent of a comparable Treasury’s yield, today their yield is about the same even though munis have a tax advantage, Evensky said. The yield increase is because of fears about the credit crunch and bond insurers.
An investor with a diversified portfolio of municipal bonds faces little risk, Evensky said. He considers this a buying opportunity, and uses municipal bond mutual funds of Vanguard, Fidelity, Thornburg and Schroder fund families for his clients.
“Municipal bonds are definitely attractive right now because the equity markets are up and down every day, while tax brackets are not going any lower,” said David Bendix, certified financial planner and certified public accountant with Bendix Financial Group, Garden City, N.Y. Bendix favors muni funds from Franklin Templeton, Rochester and Nuveen for his clients.
Investors in municipals should have a buy-and-hold mentality, experts said, weathering inevitable storms of credit risk and shifting rates. Mutual funds that invest in a portfolio of munis offer diversification not possible if an investor buys single bonds.
Downgrading of the credit ratings of insurers of municipal bonds is factored into the bonds’ discounted prices, and actual bond default rates are extremely low. It whacks their prices in the short run, and an investor’s principal can go down payday loans. But plenty of investors with a longer time horizon still see the advantages of munis.
There are differences in risk of municipal bonds, which are issued by state, city or other local governments, or by their agencies. Quality should never be disregarded.
“In 2006, when credit risk was being rewarded, we didn’t take that risk, and our performance wasn’t as good because we had very high quality short- to intermediate-maturity municipals,” said Scott Hintz, assistant vice president of mutual funds for State Farm, whose State Farm Municipal Bond Fund is the best-performing intermediate bond fund over the last 12 months. “But then the environment changed and our conservative bias floated to the top.”
National intermediate municipal bond funds with highest 12-month trailing total returns, according to Morningstar Inc., are:
•State Farm Municipal Bond Fund, $465 million in assets; “no load” (no sales charge); $250 minimum; 0.15 percent annual expense ratio; 8.18 percent return.
•Baird Intermediate Muni Bond Fund, $107 million; no load; $2,500 minimum; 0.55 percent annual expense ratio; 7.17 percent return.
•Old Westbury Municipal Bond Fund, $176 million; no load; $1,000 minimum; 0.86 percent annual expense ratio; 6.6 percent return.
•HighMark National Intermediate Tax-Free Bond Fund, $65 million; $1,000 minimum; 0.28 percent annual expense ratio; 6.4 percent return.
•JPMorgan Tax Aware Real Return Fund “A,” $810 million; 3.75 percent load; $1,000 minimum; 0.90 annual expense ratio; up 6.23 percent return.
Funds with high minimum requirements or closed to new investors were excluded.
Morningstar analysts recommend the following funds:
•Fidelity Municipal Income Fund, $5.1 billion; no load; $10,000 minimum; 0.45 percent annual expense ratio; 5.08 percent return.
•Vanguard Long-Term Tax-Exempt, $2.7 billion; no load; $3,000 minimum; 0.16 percent annual expense ratio; 4.74 percent return.
•Franklin Federal Tax-Free Income Fund, $7.7 billion; 4.25 percent load; $1,000 minimum; 0.61 percent annual expense ratio; 4.25 percent return.
andrewinv@aol.com