Portfolio Manager Perspectives

Jeff Benjamin

Surprise! Muni bonds starting to look more appealing

Rising taxes, puny money fund rates leading investors to public-debt sector; not all munis the same

Mar 29, 2010 @ 11:21 am

By Jeff Benjamin

The biggest risk in the municipal bond space right now is painting the entire market with a broad brush, according to Thomas Dalpiaz, portfolio manager at Advisors Asset Management Inc.

“There are certainly challenges in the muni bond space,” said Mr. Dalpiaz, who manages $200 million in muni bond separate-account portfolios. “But for every negative story, there are hundreds of municipalities that are working their way through this.” The firm, which has $4.2 billion under supervision, provides mostly subadvisory services for financial advisers.

Mr. Dalpiaz's muni bond strategy has generated a 4.4% annualized total return over the past five years.

The appeal of that kind of steady tax-free income is illustrated in the growth of the assets he manages, which was at just $32 million in June 2006.

While Mr. Dalpiaz acknowledges the general uncertainty surrounding the fiscal health of most municipalities, he uses that fear as a reason investors should turn to a professional money manager like himself.

“I can't deny that there are a lot of states, cities and municipalities that are in trouble. But you have to remember that they can't run a deficit,” he said. “And there are more than 50,000 separate issuers of muni bonds, so you have to be careful not to paint the entire muni bond market with a broad brush.”

Mr. Dalpiaz believes that the growing appeal of muni bonds has to do with the expectations of higher tax rates and “people getting tired of earning next to nothing on their cash.”

“The Bush tax cuts are going to expire at the end of the year, and there will be new taxes coming with this health care,” he said. “That creates demand for tax-exempt muni paper.”

Another thing that creates demand is the growing popularity of Build America Bonds, which are federally subsidized and taxable muni bonds that were introduced a year ago.

The popularity of Build America Bonds, which give municipalities another means of issuing debt, “has helped the traditional muni market because it has been sucking out supply,” Mr. Dalpiaz said. “That means the total return of traditional muni bonds goes up.”

In addition to a separate-account manager such as Mr. Dalpiaz, investors can gain exposure to the muni bond market through mutual funds. Bonds can also be purchased individually by investors and advisers.

Going it alone has gotten dicier over the past few years, however. The financial crisis hammered the credit ratings of bond insurers such as MBIA Inc. and Ambac Financial Group Inc. That, in turn, has led more issuers and investors to take a pass on the insurance.

Indeed, less than 15% of new muni bond issues are wrapped in insurance. Just a few years ago, that number was closer to 60%.

The lack of a backstop means higher yields — and potentially more risk.

“The muni world has changed over the past two years,” he said. “In the old days, you could buy bonds wrapped in a warm blanked of triple-A insurance, but now investors need to know more about the issuing municipality before buying these bonds.”

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.


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