Muni malaise

It’s no secret that municipal bond funds have handsomely outperformed stocks this year. Even so, the cash is still flowing in one direction , out of the fixed-income funds and into equity funds.

It’s no secret that municipal bond funds have handsomely outperformed stocks this year. Even so, the cash is still flowing in one direction , out of the fixed-income funds and into equity funds.

By Laurie Kaplan Singh
December 2000
Institutional Investor Magazine

According to AMG Data Services, investors poured $218.6 billion into stock funds in this year’s first ten months, up from $102.6 billion for the same period in 1999. Municipal bond funds lost $14.4 billion in assets, compared with a gain of approximately $1 billion during the same period last year. Indeed, munis have been a tough sell since Ronald Reagan’s 1986 tax package slashed the top income tax rate to 28 percent. Muni bond fund assets now total $272.7 billion.

While the average equity fund lost 6.2 percent for the year through November, versus a gain of 31.7 percent for the same period in 1999, the average municipal bond fund returned 7.2 percent, against a loss of 3.8 percent for the same period last year.

California proved to be the best-performing state in the muni bond market, as an increase in wealthy investors boosted demand for tax-exempt securities. As a result, the top-performing retail municipal bond funds for the year include Safeco California Tax-Free Income Fund, up 13.7 percent through November 28, and Schwab California Long-Term Tax-Free Bond Fund, up 11.7 percent for the same period. These funds also benefited from holding long maturities. The Safeco fund, for example, has an average weighted maturity of 24 years. “We run a very interest-rate-sensitive portfolio,” says manager Steve Bauer. “We are usually first or last in the rankings , but never in the middle.”

Though fund sales are sluggish, individual investors have been active direct buyers of muni bonds. “Strong demand from individual investors has been driving the municipal bond market all year,” says David MacEwen, a senior vice president at American Century Investment Management. That demand caused an increase in intermediate-term bond prices and flattened the municipal bond yield curve.

The demand reflects an aggressive sales effort by bond dealers, who have been pitching more retail accounts following a decrease in institutional appetite for munis. Until recently, too, in-

dividual bonds offered higher tax-free yields than the funds, which tend to hold older, lower-coupon securities. “In the wake of last year’s interest rate rise, the yields on individual bonds tended to look better than the funds, yields,” MacEwen notes. But as this year’s rally in the municipal bond market has brought yields down, many observers note that the funds, returns are beginning to look more competitive. The average current yield of the municipal bond funds tracked by Morningstar is roughly 4.8 percent.

The sector may also benefit from an extension of the flight to quality that has driven this year’s Treasury market rally. “Nationwide, supply this year is approximately 19 percent less than last year,” notes Scott Albrecht, a vice president and senior portfolio manager at Federated Investors. And in some states new bond issuance is considerably lower.

Given that municipals have done well in 2000 and investors have registered gains, not losses, year-end tax maneuvering should not have much of an impact on this market. “If anything, investors will be selling equities to book losses, and some of this money could come into the municipal market,” says Joanne Larkin, manager of the Schwab California Long-Term Tax-Free Bond Fund. “Year-end tax maneuvering could be favorable for our market.”

Institutional funds scoreboard

Lipper has ranked the following as the top ten municipal bond funds through November.

Total return

Assets
12 months
ended

Fund
($ millions)
11/27/00

Smith Barney Managed Municipals
$1,920.90
9.09%

Excelsior Long-Term Tax-Exempt
120.4
8.94

Safeco Municipal Bond
482.5
8.9

Schwab Long-Term Tax-Free Bond
74.8
8.84

Harris Insight Tax-Exempt Bond
106.4
8.7

Eaton Vance Municipal Bond
82.2
8.51

Consulting Group Capital Markets Municipal Bond
47.4
8.48

Vanguard Long-Term Tax-Exempt
1,648.60
8.22

Dreyfus Basic Municipal Bond
224.7
8.1

Saratoga Municipal Bond
9.8
8.06

Source: Lipper.

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