Municipal bond market has a lot to offer

N.Y. issues fairly strong, even in Sept. 11 aftermath

July 07, 2002|By Eric Jacobson | Eric Jacobson,MORNINGSTAR.COM

All in all, things have been looking pretty good in the muni market this year.

That might seem a bit counterintuitive given the concerns faced by New York in the wake of last September's terror attacks. Add to that the hangover from California's power crisis, which promises to add a glut of supply to that state's muni market later this year. But while the latter has put some modest pressure on California bonds, New York issues have been fairly strong.

Meanwhile, the municipal market has surged past the taxable universe. The Lehman Brothers Municipal Bond index topped the Lehman Brothers Aggregate index by 67 basis points for the year to date through June 25. If there's a factor one can easily point to for an explanation, it's that munis were especially cheap at the end of last year, presenting an alluring place for investors to put money as they've shifted lots of assets into bonds during the past several months.

With interest rates at historical lows, there's little question that the main risk is the prospect of rising rates and principal loss. For investors who need muni exposure, however, this category - and our analyst picks - have a lot to offer.

Fidelity Spartan Municipal Income (FHIGX)

A new addition to our analyst picks. We nonetheless have tremendous confidence in this fund's manager, Christine Thompson, and adviser, Fidelity. The firm has come as close to perfecting the practice of muni-bond management as we've seen. With a terrifically modest price tag and analytics that match up against anyone's, this fund is a terrific choice.

Franklin Federal Tax-Free Income A (FKTIX)

This is the largest muni-national long-term fund for good reason. Manager Sheila Amoroso uses a buy-and-hold approach, looking for bonds offering competitive yields and trading at reasonable prices. As has been the case with many of its siblings, this fund has earned an enviable record of solid returns and moderate volatility.

Franklin High Yield Tax-Free Inc A (FRHIX)

A good choice for those who are willing to take on a little more risk. The fund is run in a similar fashion to Franklin Federal Tax-Free Income, but it has a mandate that allows it to buy lower-quality, higher-yielding bonds than that fund. Credit risk, therefore, is more of an issue for a fund such as this, and a rough stretch in 1998 illustrates the point. The fund sports a gigantic asset base, though, and is well diversified, so its risks aren't likely to get completely out of hand. With decent long-term returns - despite a weak 2000 - and a high level of income, it's worth considering for those who are willing to be more aggressive.

Vanguard High-Yield Tax-Exempt (VWAHX)

This fund has its cake and eats it, too. Although it's considered a high-yield muni fund, this portfolio doesn't have to take on as much credit risk as rivals with the same mandate. Not surprisingly for a Vanguard fund, low costs are the reason. Because the fund chews up very little yield with its expense ratio, it can afford to pay a lot more of its earned income and thus stay competitive with other high-yield muni funds.

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