| BOSTON, Sept 3
BOSTON, Sept 3 Nothing says Massachusetts like
the John Hancock Massachusetts Tax-Free Income Fund.
But bonds issued by Puerto Rico account for 13 percent of
the $101 million municipal bond fund's assets. And like many
other municipal bond mutual funds that loaded up on the
Caribbean island's debt, the John Hancock fund has
generated a dismal return for investors so far in 2013.
Some U.S. money managers have been enticed by the tax-exempt
status of Puerto Rico bonds and juicy yields that have topped 8
percent in recent trading.
But danger was lurking. The S&P Municipal Bond Puerto Rico
index declined 8.88 percent in August, compared to a 1.68
percent loss in the S&P National AMT-Free Municipal Bond Index,
as dealers already spooked by Detroit's bankruptcy fretted about
the island's fiscal stability.
In a further sign of the growing perceived risks, Puerto
Rico's spread ballooned to 320 points last week, the widest for
10-year bonds over Municipal Market Data's triple-A scale and
nearly double Illinois' 165-point spread.
Funds that bet heavily on Puerto Rico are now some of the
worst performers among municipal bond funds in 2013, according
to an analysis of data from Lipper Inc, a Thomson Reuters
Of the 20 municipal bond funds with the highest percentage
of Puerto Rican debt, 16 are getting beat by at least 60 percent
of their peers.
Puerto Rico bonds are attractive to U.S. municipal bond
managers because they are exempt from federal, state and local
income taxes in any U.S. state. Investment in Puerto Rico is
within bounds for a single-state municipal bond fund as long as
at least 80 percent of its income is state tax-exempt, according
to the Securities and Exchange Commission's fund naming rules.
Puerto Rico is one of the top issuers of bonds in the United
States with $52 billion in outstanding tax-supported bonds
compared to $96 billion in California. Investors, however, are
often not aware of Puerto Rico's weighting on their state
"When buying a Connecticut municipal bond fund, for example,
one would expect Puerto Rico to have as much bearing on the
portfolio as Alaska," Morningstar analyst Steven Pikelny warned
in December. "This would be a big mistake."
With chronic double-digit unemployment rates and a dwindling
population, the U.S. commonwealth of Puerto Rico has long run
substantial budget gaps. The island has yet to produce balanced
budgets sought by institutional investors and bond analysts
Investors have pulled money out of municipal funds for 14
straight weeks, owing largely to Detroit's largest municipal
bankruptcy in U.S. history, problems in other cash-strapped
American cities and concerns about Puerto Rico, according to
analysts. The concerns have whipsawed the $3.7 trillion
municipal bond market, which is now taking a closer look at
Puerto Rico's large, unfunded retiree obligations and persistent
"While Puerto Rico yields are high, the risks are high too,"
said Michelle Knight, who runs $600 million in muni bonds at
Boston's Silver Bridge Advisors. "This is a structurally flawed
economy with unsustainable debt levels that has too many black
marks to make it enticing, at least to me."
Managers of Franklin Templeton's $581 million Double
Tax-Free Income Fund did not think so. With about 63
percent of its assets in Puerto Rican debt, the fund had the
highest allocation among municipal bond funds, according to
Lipper. The fund also is down 13 percent this year.
A spokesman for Franklin Templeton said money managers were
not available to comment for this story.
John Hancock's Massachusetts fund is down 8.77 percent
during the first eight months of 2013, lagging 87 percent of the
funds in its category. John Hancock funds are part of Canada's
Manulife Financial Corp.
In contrast, Fidelity's $2 billion Massachusetts Municipal
Income Fund, with only about 2 percent of its assets
in Puerto Rico debt, is down 5.93 percent, or better than 80
percent of its peers, according to Morningstar.
On March 13, S&P cut its general obligation credit rating
for Puerto Rico to BBB-minus, or one notch above junk status,
warning Puerto Rico's fiscal problems were proving difficult to
But even after that dire warning from a top U.S. credit
ratings agency, the John Hancock fund still liked Puerto Rico
"Despite the volatility, we are maintaining the fund's
position in Puerto Rico bonds," said Dianne Sales, the fund's
portfolio manager, in a semiannual report for the period ended