IT'S EXCITING TO wade into choppy markets, make big bets on risky sectors, exploit the fear and greed of lesser mortals. It's even more exciting when the best deals show up in a "safe" area of the market — like municipal bonds. Indeed, at yields higher than those of Treasurys, muni-bond returns are looking downright stock-like, with just a fraction of the risk.This doesn't happen often, and it's a testament to the breadth and depth of the credit crunch. Because of their tax advantages, munis typically yield between 80 and 90 percent of a comparable Treasury bill. But since muni income is tax free, investors in higher tax brackets are generally still better off. In times of crisis, demand for Treasurys spikes, pushing prices higher and sending yields lower, occasionally down into muni territory. This time, though, that's only half the story. While Treasury yields have been falling, muni yields have been rising, for two reasons: It began when hedge funds started selling munis en masse to cover short positions and was exacerbated by fears about the instability of the big bond insurers. Now investors can find munis with yields as much as 25 percent higher than a comparable T-bill's. Factor in their tax-free aspect and munis can end up yielding almost twice as much as Treasurys. "This whole scenario is unprecedented," says Paul Brennan, who manages municipal-bond funds for Nuveen.
For more SmartMoney Magazine features, turn to the June issue.
Generally speaking, Treasurys are still considered the safest of all bonds, but a state hasn't defaulted on a general obligation bond since before the Civil War; overall, the default rate on munis has been 0.1 percent over the past decade. Still, with more than 1 million issues to choose from, the market can be gnarly for individual investors. To winnow the field, forgo sectors with a relatively high rate of default, like airport-revenue and electric bonds, says Harold Walton, director of fixed income at Buckingham Asset Management. And forget illiquid bonds from tiny municipalities. The better option? General obligation bonds, like a Maryland issue due in 2020 with a 4 percent yield (equivalent to 6.2 percent taxable yield), or a Kansas City, Mo., bond, due in 2025 with a yield of 4.7 percent (tax-equivalent: 7.3 percent). To help in your search, the Municipal Securities Rulemaking Board just launched a research tool at
emma.msrb.org.
Muni-bond funds offer the same tax benefits without the legwork, though yields on the funds will normalize over time. Because returns don't vary widely from fund to fund, keeping costs down is key, says Scott Berry, a Morningstar analyst who covers muni-bond funds. Vanguard's Intermediate-Term Tax-Exempt Bond fund has a yield of 4 percent and costs just 0.15 percent.
Access to the Muni Market Fidelity Intermediate Municipal Income ( FLTMX) — 3.8% yield Seligman Select Municipal ( SEL) — 3.8% yield Vanguard Intermediate-Term Tax-Exempt ( VWITX) — 4.1% yield |
For a little more octane, analysts suggest closed-end funds. Because they trade on an exchange, these funds often have a share price below the value of their holdings — and right now some closed-end muni funds are trading at significant discounts. The best deals are among funds that borrow money to enhance yield, known as leverage. Like with all credit, there's tumult here, too — which is one reason why the discounts on leveraged funds are so wide. For those willing to take the risk, Cecilia Gondor, an analyst with Thomas Hertzfeld Advisors, recommends Seligman Select Municipal, which is trading at a 14 percent discount, in spite of a high-credit portfolio that yields 4.1 percent.
Four muni exchange-traded funds debuted at the end of 2007. They're all more expensive and less diversified than Vanguard's actively managed fund. But whatever approach you take, no one expects the opportunity in munis to last much longer. For an inflection point, keep an eye on Treasury yields, which will rise ahead of munis.
Order Reprints
0.01
