No New Issuance

Closed-end municipal-bond funds traded Monday at an average discount of 8.39 percent to their net asset values, the largest discount since April 2009, said Cecilia Gondor, executive vice president at Miami-based Thomas J. Herzfeld Advisors Inc. The discount narrowed to 5.48 percent at the close of trading Wednesday.

Declining new issuance has limited the supply in the municipal-bond market, and many investors value the tax-exempt income provided by the bonds, said Josh Gonze, a co-portfolio manager who oversees $6.5 billion in municipal-bond assets at Thornburg Investment Management Inc. in Santa Fe, New Mexico. The funds he manages have not seen any significant inflows or outflows this week, Gonze said.

There was $141 billion in municipal-bond issuance in 2011 through July, compared with $216 billion in the first seven months of 2010, said Thomas Doe, chief executive officer and founder of Concord, Massachusetts-based Municipal Market Advisors.

Best Defense

Bonds issued by providers of essential services such as utilities should be less vulnerable to the effects of any future cuts in government spending, said Howard Cure, director of municipal-bond credit research for Evercore Wealth Management LLC in New York, which oversees about $2.9 billion.

Evercore recently purchased bonds issued by the Puerto Rico Electric Power Authority that mature in 2019 at a yield of 4.04 percent. Interest from Puerto Rico municipal bonds is generally exempt from state and local income taxes for residents of any state.

"We think that diversification is our best defense," said Elizabeth Fell, head of U.S. fixed-income strategy at Barclays Wealth, which manages about $272 billion. Fell, who's based in New York, is advising clients to hold general-obligation and certain revenue bonds.

There may be better opportunities among high-yield municipal bonds, which individual investors may not be able to analyze, said Jason Thomas, chief investment officer at Aspiriant, which manages about $7.5 billion.

No Flashing Sign

"The municipal-bond market is driven by the retail investor, who is drawn to the apparent safety of general- obligation municipal bonds," said Los Angeles-based Thomas.