By Jonnelle Marte
Investors in search of safety, yield — and a sweet tax break — continue to pour money into muni funds.
Municipal-bond funds, including exchange-traded funds, took in $800 million during the week ended July 25, the 15th consecutive week of positive flows, according to Lipper, a research firm. In fact, muni funds have had only three weeks of outflows over the last 47.
What’s behind the hot streak? Analysts say some investors are snapping up munis to increase their tax-exempt income, especially with the Bush-era tax cuts due to expire at the end of the year if Congress doesn’t act; municipal bond income is free from federal taxes and many state and local taxes. Others, they say, are simply chasing performance. Muni funds are up nearly 6% this year, following a 9% gain in 2011.
But with yields on munis near all-time lows – the average Triple- A rated 10-year muni yields 1.57%, down from 3.17% at the start of 2011 — some analysts say those attractive returns can’t last. Matt Fabian, managing director of research firm Municipal Market Advisors, wrote this week that the municipal bond market could get “whipsawed by rapid moves in U.S. Treasurys” because rates are near record lows. “The stakes are higher as yields get lower and lower because prices become more volatile,” says Fabian. Such price moves could spook investors who already unhappy with lower yields and may be looking for a reason to sell their bonds, he says.
Meanwhile, as the Wall Street Journal recently reported, some investors are worried the recent spate of municipal bankruptcies could be a sign that more cities are defaulting strategically — and not out of necessity — as a way to reduce their debt loads. Such a shift could make investors more wary of borrowing from state and local governments, says Tom Roseen, an analyst at Lipper.
Still, many investors continue to favor munis, noting that defaults remain low. So far this year, 41 municipal bond issuers defaulted for the first time, compared to 68 by the same time last year, according to Municipal Market Advisors. “We’re on pace to have the lowest amount of defaults in three years,” says Fabian. Anthony Valeri, fixed income strategist for LPL Financial, prefers intermediate and long-term munis because they offer the most attractive yields. While they would also be most sensitive to a rise in interest rates, Valeri says he expects slower growth and lower inflation expectations to keep rates low and performance stable.