You’d expect the sidelines to be crowded now with investors still holding back, waiting for municipal bond yields to turn higher before committing investable funds to the market. It turns out, however, that the action is on the field, and those waiting for the perfect moment to invest have determined there’s no time like the present.
According to Bloomberg, U.S. municipal mutual funds have seen inflows so far this year of $11.4 billion, the best yearly start since 1993. That’s a dramatic contrast to last year, when the ranting of public-finance doomsayers was at a fever pitch and individuals pulled $21 billion from local-government mutual funds, a level not seen in 20 years.
What’s behind investors’ appetite for municipal bonds?
Less stress
Despite their modest yields, municipal bonds provide considerably less drama than equities. Bleak news from Europe and recent stock-market plunges highlight the staid virtues of munis.
Importantly, the news on state budgets has brightened considerably. In a state budget update released by the National Conference of State Legislatures, more than half the states and the District of Columbia expect to show modest surpluses in their fiscal-year revenues – the first time since the recession, The Bond Buyer reported.
Revenue collections have met or exceeded expectations, the report said, and in some cases have even exceeded pre-recession levels.
Of course, there are still hurdles. Economic uncertainty remains and many states expect to face financial issues in the next fiscal year. But for the first time since 2008, legislators from most states didn’t kick off their legislative sessions dealing with budget woes.
Investors look ahead
The case for munis is also bolstered by an assessment of the political winds. Many investors expect taxes to rise after the upcoming presidential contest, further enhancing the appeal of tax-free income.
There is also the issue of supply. As Forbes noted in a recent report, a superficial reading of the numbers shows the total amount of new issues through April 2012 is about twice what it was during the same time last year. But almost 70% of “new” issues were refinancings. Over the next several months, according to the report, about $140 billion of distributions/returns will be returned to bond holders, while only $140 billion will be issued in brand-new munis.
(As we pointed out in “The Upside of Lower Rates” , refundings can also provide certain opportunities for investors.)
And the alternatives?
In comparison to other investment vehicles – corporate bonds, Treasuries, commodities and stocks – munis just make sense.
In tumultuous times, risk is especially important. Bloomberg, in a report, paints a stark picture for the average cumulative default rates from 1970-2011 of munis vs. corporate bonds. For “AAA” bonds, the 10-year cumulative rate for municipal bond defaults is zero, compared with 0.48% for corporate bonds; for “AA”-rated bonds, it’s 0.01% for munis vs. 0.86% for corporates. The wide disparities continue as rating quality decreases.
Tepid interest rates haven’t deterred common-sense investors because municipal bonds don’t require a crystal ball. There is no need to be a soothsayer and focus on the minute-by-minute machinations of the markets. In fact, the cost of waiting for a magical moment to invest has been particularly punishing as rates have continued to decline.
The only prerequisites for success are a clear understanding of the quality of bonds you’re buying and a desire to generate tax-free income.