Fitterer also says that in a rising interest rate environment, munis historically have provided better price protection because of the tax-exempt income they produce. A 10-year muni usually trades around 75%-80% of the yield on a 10-year Treasury. Therefore, if 10-year Treasury yields increase by 100 basis points, 10-year muni yields should only increase by about 75-80 basis points. This equates to less downward movement in municipal bond prices relative to Treasurys.
John R. Mousseau, CFA, managing director and portfolio manager of the tax-free section of Cumberland Advisors, an RIA firm headquartered in Sarasota, Fla., says long-term tax-free bonds currently offer the best buying opportunity he has seen in over a year.
In Mousseau's view, the meltdown came about because of a "perfect storm" of several events. "You had higher Treasury rates, a spike in the tax-free [bond] supply due to the Build America Bonds (BABs) program being discontinued. This supply spike contributed to a drop in prices, which in turn spurred muni fund redemptions. This was exacerbated by Meredith Whitney's predictions of defaults-which we disagree with."
Normally, the tax-free bond market is retail driven, not institutionally driven. Things have gotten turned around, says Mousseau. "Now you have institutional money in the taxable bond market buying municipal credit because of the generous spreads over Treasurys, while the retail investor in the tax-free bond market is abandoning municipal credits."
Muni fund manager Guy Benstead, who helms the $178 million Forward Long/Short Credit Analysis Fund, blames the turmoil on a combination of scare-mongering headlines and actions by states like Illinois (in raising taxes) and California (in proposing an extension of tax increases set to expire this year as a way to help balance the state budget).
Benstead maintains states have an ample supply of muni bonds available, since many have already issued muni bonds for this year, and he predicts a rush back to munis in the second half of 2011, barring a rise in redemptions, which will push prices up.
Mike Walls, who manages Ivy Municipal High Income Fund and the Advisor Municipal High Income Fund, with a total of $930 million in assets in both vehicles, basically agrees.
"The problem is that non-muni people try to portray the market as a plain vanilla market, and it's much more dynamic than that. The vast majority-about 70% of bonds in the muni market-are revenue bonds," says Walls. "These have specific earmarks, a revenue source that's meant to pay back bondholders."
The Ivy Municipal High Income Fund, which takes a low-volatility approach to the sector, continues to be one of the top performers in its category, ranking No. 1 in annualized performance for the one-year, three-year and five-year periods, according to Morningstar.
Dan Moisand, principal of Moisand Fitzgerald Tamayo LLC in Melbourne, Fla., has been telling clients, "This is not a time to be fearful and don't be afraid to buy good quality muni bonds.
"The advice is basically: Let the people with poorly diversified or with at-risk issues do all the freaking out they want," says Moisand. "If we don't get caught up in that, we have reliable tax-free income to enjoy and possibly can get more for a good price."