"Diversification is critical now," says Strickland. "That means geographic diversification as well as diversification among bond insurers."
Consider getting "credit aggressive." After years of tight credit spreads in the muni market, investors are finally getting paid to take some risks as the difference between highly rated securities and those further down the credit ladder continue to widen.
"This may not be a bad time to take on some added risk in the municipal area and to leg into higher-yielding securities as credit spreads widen," says Schechter. "High-yield municipals are not as cyclical as high-yield corporate bonds and not as susceptible to a recession. Municipalities can cut back spending or raise taxes to make up for declining property tax revenues."
Fabian, noting that a triple-A-rated corporate bond has ten times the default risk of an A-rated municipal, agrees that this is a good time to "take a credit-aggressive strategy" for the right clients. "Ninety percent of all municipal defaults occur in four sectors-corporate-backed bonds, continuing-care facilities, multifamily homes and land speculation," he says. "If you stay within safe sectors such as water and sewer projects or airports, the risk of default is extremely low."
Look at munis for investors in lower tax brackets. At the same time that the municipal market was adjusting to unanticipated selling from hedge funds and the fallout from insurer issues, the Treasury market was gaining strength, resulting in lower Treasury bond yields. Meanwhile, yields on municipal bonds have remained buoyant because their prices having been weighed down. Those factors have compressed municipal spreads relative to Treasurys to a sliver. In some cases, yields on municipals exceed those of Treasurys.
Even so, municipal yields remain relatively low on an absolute basis. In mid-January, the "consensus" yield of a two-year triple-A-rated municipal general obligation security was 2.82%, a taxable equivalent yield of 4.34% for someone in the 35% federal tax bracket and 3.32% for someone in the 15% bracket. At the same time, a two-year Treasury was yielding 2.44%, according to Municipal Market Advisors. The close relationship persisted all along the yield curve.
With tax-free yields approaching or equal to taxable Treasury yields, municipals have become appropriate even for the taxable accounts of investors in lower tax brackets, particularly for shorter-maturity bonds where yield spreads between Treasurys and municipals are usually much wider.
Given unusually narrow spreads at the shorter end of the yield curve and the potential for rising interest rates, "it's probably a good idea to stay with an average portfolio duration of five years or less," advises Strickland. "I wouldn't go longer than ten years."
Take a longer-term view. This year could see a steep yield curve if the economy heads south, if there is a Fed-inspired drop in short-term rates and if there is inflation. Yet despite short-term concerns, some of the favorable long-term trends and tried-and-true features that gave munis a push in the past are still in place. "I have trouble believing that tax rates are going to come down anytime soon, and as baby boomers hit retirement age, there will be increased demand for safety and tax-free income," says Schechter.