The municipal bond market has had a rough ride in the last six months, but that could mean now is a good time to invest in the sector.
For the second consecutive quarter, fallout from the sub-prime-induced credit crunch sent yields rising on most muni securities, although they didn't jump as high as they did in the first quarter. A major concern remains the financial condition of the insurance firms backing many muni bonds because those insurers are also on the hook for billions of dollars in losses on mortgage bonds.
"We here in muni-land are fraught with several problems," said Marilyn Cohen, president and chief executive of Envision Capital Management in Los Angeles. "There's the whole credit crisis, the fact that the insurance isn't worth the paper it's written on and the possibility of rising interest rates."
That combination spells risk but also the possibility of bigger-than-usual rewards in the form of higher yields.
"There are tremendous opportunities," Cohen said.
Most categories of mutual funds that invest in the obligations of state and local governments were in the black for the second quarter, but only barely. For example, long-term muni funds on average were up 0.8% for the period but down 0.8% for the first half of the year. Long-term California muni funds gained 0.9% in the latest three months and were down 1.1% year to date. High-yield muni funds returned 0.4% in the quarter, and were off 2.7% for the first half.
The performance reflects the rise of yields during the quarter. Because a bond's yield and its market value move in opposite directions, if you already own muni bonds, you want yields in the muni market to go down, not up. But if you're thinking of getting into the market, a relatively high yield on a bond means it's relatively cheap.
Although muni yields retreated since the second quarter ended Monday, they remain elevated compared with their average level in recent years. And the fact that interest on munis is exempt from federal and often state income tax only increases their attraction.
"If investors are paying any taxes on their investments at all, they should consider municipal bonds at these prices," said Scott Berry, fund analyst at mutual fund tracker Morningstar Inc. in Chicago.
