(The author is a Reuters contributor. The opinions expressed
are his own.)
By Lewis Braham
PITTSBURGH, March 21 One could forgive municipal
bond investors for being confused. While the average muni bond
was down 2.6 percent in 2013, making it one of the
worst-performing bond sectors this year, munis are already up
3.1 percent through March 19, making it one of the best.
Many of the conditions that existed last year continue
today. Muni investors are still worried about the outcomes of
the financial struggles of Detroit and Puerto Rico. And there is
still persistent fear of rising interest rates decimating bond
values. (Bond prices move inversely to rates.)
So what gives?
Reuters asked a number of 2014 U.S. Lipper Fund Awards'
winners for answers.
While Detroit's bankruptcy played a role last year, manager
Peter Hayes of BlackRock Strategic Municipal Opportunities Fund
, a winner of the 2014 U.S. Lipper Fund Awards, says
the spike in interest rates that occurred last May did most of
From May 1 through the end of July, the 10-year U.S.
Treasury bond yield rose from 1.66 percent to almost 3 percent
as investors panicked about the Federal Reserve bank scaling
back its bond-buying program.
While investor concerns about rising rates persist, Hayes
says bonds are now priced more appropriately.
"When yields were very low in 2011 and 2012, investors began
to take on too much risk, buying high-yield bonds and bonds with
long durations," Hayes says.
But now, you can get a 3.35 percent tax-free yield on a
10-year A-rated muni compared to just 2.78 percent on a taxable
10-year Treasury bond. And you can get up to 3 percentage points
extra if you're willing to buy regular high-yield municipals,
and even more than that for the truly distressed plays in
Detroit or Puerto Rico.
Aside from the added yield, driving the comeback is a
shortage of muni bond supply, where there is a 30 percent
decline in new issuance this year, Hayes says. Add to that the
fact that income tax rates on the wealthy went from 35 percent
to 39.6 percent - or 43.4 percent if you include the new 3.8
percent Medicare tax on the ultra-rich - and you've got the
makings of a rally.
Arguably the best values in the muni sector are now in
high-yield bonds. To take full advantage of the sector, Hayes
tweaked his fund's investment strategy and changed its name this
January from the BlackRock Intermediate Municipal Fund to its
current Strategic Municipal Opportunities.
This has given him greater latitude to buy high-yield bonds,
the exposure for which he's doubled from 7 to 14 percent this
year. And he can play offense or defense with the maturities of
the bonds he owns depending on which way he thinks rates are
going. (Long-term bonds are more sensitive to rates than
Most of the other 2014 U.S. Lipper Fund Award Winners are
also fans of high-yield debt.
"Despite the headlines about Detroit and Puerto Rico,
default rates in the high-yield municipal bond market have
stayed very low," says Troy Willis, co-manager of the
Oppenheimer Rochester AMT-Free Municipal Fund.
Indeed, Willis sees the negative press about Puerto Rico as
an opportunity. His fund has a 10.2-percent Puerto Rico
"We are the largest institutional holder of Puerto Rico
bonds," Willis says. "We don't think it will default like
Detroit's population declined by 60 percent in the last 40
years while Puerto Rico's has grown 2.2 percent, increasing the
number of people who can pay taxes to cover its muni bond debt,
Also, the island commonwealth recently shifted its pension
plan for government employees to a more affordable 401(k)
retirement plan and increased the age at which existing
pensioners can receive their benefits. That's bad for employees
but good for Puerto Rico's budget. Its deficit has been
shrinking from $3.3 billion on June 30, 2009, to an estimated
$650 million by June 30, 2104, according to Willis.
The yields on Puerto Rico debt are extraordinary in a
"I can find Puerto Rico Electric Power Authority munis
yielding 10 percent tax-free," says manager Michael Walls of Ivy
Municipal High Income, another Lipper winner and
Puerto Rico fan.
That translates to a 16.6 percent tax-adjusted yield for
those in the highest 39.6 percent bracket. General obligation
bonds issued by the Puerto Rican government currently yield
upwards of 8 percent - or 13.2 percent on a tax-adjusted basis.
Still, not every Lipper winner is buying the Puerto Rico
Even if some newly issued 2-year Puerto Rico bonds yield 10
percent, the average recovery rate on defaulted municipal bonds
for investors is only 60 cents on every dollar invested, says
Chris Ryon, co-manager of the Thornburg Limited Term Municipal
"You could make 20 percent but lose 40 in two years," he
says. "Not such a good deal."
Of this year's muni winners, Ryon's fund is probably the
most conservative strategically. Ryon only holds high-quality
investment-grade bonds rated BBB or better. He also keeps the
maturities of his bonds less than 10 years so that the fund is
less sensitive to interest rates.
He thinks the best values can be found in bonds within the
7- to 10-year maturity range.
He likes 10-year AA-rated bonds from Rhode Island which has
"a great Treasurer," pension spending that's under control and
bond yields of 3.2 percent - about 0.70 percentage point higher
than the average AA-rated bond.
BlackRock's Hayes favors B-rated municipal airport bonds in
New Jersey issued by companies such as United Continental
Holdings or US Airways. These yield in excess
of 5 percent - or 8.3 percent tax adjusted. Maybe that's not at
Puerto Rico levels but it beats the 2.78 percent you'll get on a
10-year Treasury note any day.
(Editing by Lauren Young and Bernadette Baum)