Q: Given how volatile the municipal bond markets were last year, why should investors trust them?
A: The volatility was not created by problems with the underlying credit quality of the issuers but rather a temporary lack of liquidity, which has improved in the last several months. Investors can trust the municipal bond-issuers that have demonstrated a long-term track record of solid financial performance and conservative management policies.
Muni bonds are a very compelling buy right now for three reasons: First, the yields on tax-free bonds are higher than U.S. Treasury securities with the same maturity dates. Secondly, muni bonds as an asset class are generally less volatile than other fixed- income investments and in chaotic markets can add stability to a portfolio. Finally, the safety factor of the strongest municipal issuers is very desirable in these uncertain times.
Q: Given that tax revenues are falling, how do you judge whether an issuer is at risk of default?
A: Historically, defaults for municipal bonds have been very low, much lower than corporate bonds. The current economic situation will put a strain on most government entities.
We look at a wide variety of financial ratios, management policies, real estate market trends, demographic trends, taxation policies and legislative developments.
Here in Colorado we are experiencing the need to make significant adjustments to current and future budgets at all levels of government. Our problems are not quite as severe as other areas of the country, but that does not make the cuts any less painful.
Q: Interest rates fell after the Federal Reserve said it would purchase up to $1.2 trillion in debt instruments. How did muni bonds respond?
A: The immediate market response was a decline in interest rates for government bonds. Municipal bond yields also declined but not by as much, depending on maturity and quality. High-quality municipals are still a good buy relative to U.S. Treasurys.
Edited for length and clarity by Aldo Svaldi.
