Muniland’s flight risk

I’m not a big fan of municipal bond-related mutual funds because some of their structural features work the opposite way that municipal bonds work. Mainly, the value of muni bond funds decline as interest rates rise. The has a useful description:

Advisers and investors appreciate being able to obtain even the current 1.8% yield from 10-year U.S. Treasurys. But many likely don’t realize the effects when interest rates rise, said James Swanson, chief investment strategist at MFS Investments. With the 10-year Treasury at a duration of about nine years, an investor faces a 9% cut to principal if interest rates rise 1% over the next 12 months and an 18% cut if rates increase 2%, he noted.

Did you catch that? If interest rates rise 1%, an investor could lose 9% of the value of his/her mutual fund. This negates one of the prime reasons to own municipal bonds for the long term:  the preservation of principle. If you are looking for the highest returns and you are willing to rotate into and out of bond funds as markets move, you might not suffer any principal loss. But that requires paying close attention to market direction and timing. Retail investors who are choosing retirement funds or putting aside cash are not generally good market timers. If an investor makes a choice and then sticks with it, the investment principal may be gone before they realize it.

I learned about an interesting structural problem with muni-related mutual funds yesterday when I was chatting with Tom Metzold, senior portfolio manager of Eaton Vance. He mentioned that unlike equity and corporate bond funds, there are no steady investor flows into municipal bond mutual funds. Since muni bonds are tax-free assets, placing them in a tax-deferred 401(k) account would actually increase an investor’s tax burden. So the steady inflows of investor cash that flow into equity and taxable bond funds does not provide ballast to muniland.

This lack of steady retail cash exposes muni bond mutual funds to much more volatility during periods of changing  interest rates and one-off spooks like when Meredith Whitney predicted a wave of defaults in muniland in late 2010.

A little of this, a little of that

Minnesota reaches a deal

Minnesota agrees on a budget, ending a two week shutdown. But is it just accounting tricks? From the (emphasis mine):

Minnesota Gov. Mark Dayton and top Republicans agreed Thursday to end a budget impasse that prompted the longest state government shutdown in recent history.

Dayton said the state government would be back in business “very soon,” but he didn’t say exactly when.

Muni sweeps: New growth or decay?

The New York Times food writer, Mark Bittman, has written the loveliest piece about his visit to our nation’s most devastated urban area, Detroit. He says there are little seeds of hope and change growing there:

Imagine blocks that once boasted 30 houses, now with three; imagine hundreds of such blocks. Imagine the green space created by the city’s heartbreaking but intelligent policy of removing burnt-out or fallen-down houses.

Now look at the corner of one such street, where a young man who has used the city’s “adopt-a-lot” program (it costs nothing) to establish an orchard, a garden and a would-be community center on three lots, one with a standing house. (The land, like many of the gardens, belongs to the city and is “leased” for a year at a time. But no one seems especially concerned about the city repossessing.)

Muniland “dumb money”


There has been a lot of speculation about the intensity of municipal mutual fund outflows. Investors have headed for the exit for the last 21 weeks. Does this exodus give us an accurate read on the health of the municipal securities market?

Two charts. Two views.

One is the “dumb money” view and the other is the “smart money” view. [No disrespect to anyone reading this blog.]

On Wall Street retail investors and small pension funds are known as “dumb money”. This is because these investors have less knowledge of the practices of the securities markets and less access to sophisticated information. Mutual funds are usually considered products for “dumb money”.

  • # Editors & Key Contributors