Municipal bonds still a good deal

Andrew Leckey

July 07, 1992|By Andrew Leckey | Andrew Leckey,Tribune Media Services

It's the only game in town. With more than $10 billion in `D municipal bonds being called for early redemption starting this month, bondholders face disappointing current tax-free yields of about half the level of 10 years ago.

So what will many of them be investing in next? More municipal bonds, of course. Even with those seemingly paltry 6 percent yields.

"Don't stay out of the municipal market the next two years and put money in cash instruments in anticipation of yields rising from record lows, for even low inflation will eat away at your dollar," warned Christine Carter Lynch, managing editor of the monthly Lynch Municipal Bond Advisory in Santa Fe, N.M.

Despite lower yields, the municipal bond remains, "the only game in town" in legal tax-free shelters, she said. So most investors in higher tax brackets who check after-tax returns will likely stick with municipal bonds, she said.

Put money in municipals of no longer than 10 years, remaining positioned to sell them to take advantage of higher interest rates when they rise again.

"I'm afraid that investors will start going to lower-quality municipals for higher yields and that won't get them much value," said Thomas Conlin, portfolio manager of the Strong Municipal Bond Fund. "When you look at how narrow the spread between yields of high-grade vs. low-grade bonds is, it is simply not worth the risk." Conlin has, in fact, been selling lower-grade municipals and reinvesting in higher quality.

While holders of individual municipal bonds face direct calls of their bonds, shareholders in bond funds will see a gradual erosion of their returns as higher-rate bonds in portfolios are called.

The best-performing municipal bond funds in total return (yield plus appreciation of underlying bonds) thus far in 1992, according to Morningstar Inc., have been:

* Strong Municipal Bond, Milwaukee; $165 million in assets; no-load (no initial sales charge); $2,500 minimum initial purchase; average credit quality of AA-; 6.59 percent trailing 12-month portfolio yield; up 5.36 percent.

* Eaton Vance National Municipals, Boston; $1.3 billion in assets; 6 percent load; $1,000 minimum initial purchase; mixed credit quality, including some non-investment-grade bonds; 7.04 percent trailing 12-month portfolio yield; up 4.89 percent.

* Olympus National Tax-Free, Los Angeles; $6.92 million in assets; 4.75 percent load; $500 minimum initial purchase; average credit quality of BBB+ to A; 6.79 percent trailing 12-month portfolio yield; up 4.71 percent.

* GW National Municipal Income, Los Angeles; $206 million in assets; 4.54 percent load; $1,000 minimum initial purchase; average credit quality of A; trailing 12-month portfolio yield of 6.68 percent; up 4.54 percent.

* Transamerica Tax-Free Bond "A," Houston; $48 million in assets; 4.75 percent load; $1,000 minimum initial purchase; average credit quality of BBB+ to A; trailing 12-month portfolio yield of 6.35 percent; up 4.49 percent.

A general low-interest-rate environment is behind the current bond situation. Many municipal bonds are issued with provisions that allow the bond to be redeemed before its maturity date 10 years after its issuance. With rates substantially lower now than 10 years ago, issuers are turning to bond calls.

"The after-tax return is what the investor should be looking at, and that is still attractive," said Richard Ciccarone, senior vice president with Kemper Securities Group.

For example, a 10-year Treasury bond lately has been at 7.18 percent, he pointed out. On the other hand, the average municipal bond converted to an after-tax return (free of federal tax) offers an 8.12 percent yield to a taxpayer in the 31 percent bracket. There's a 7.78 percent after-tax yield to a taxpayer in the 28 percent tax bracket.

"My motto is to diversify and pray," said John Austin, a Washington-based certified financial planner.

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