MORE ON BONDS
Some analysts now are recommending municipal bonds.
Munis, which are issued by state and local governments, provide income that is exempt from federal tax. For someone in the 28% federal tax bracket, for example, a municipal bond yielding 5% provides the same after-tax yield as a corporate bond paying 6.9%. For those in higher federal tax brackets, the taxable equivalent yield is even greater.
And municipal yields now compare more favorably than usual with Treasury bonds, the traditional security of choice for investors seeking a safe haven. (Income from Treasury securities is taxable at the federal level but is exempt from state tax.)
Despite the well-publicized default of Orange County, Calif., “the reality is that defaults in this market are very, very rare,” said Kieran Beer, editor-in-chief of the Bond Buyer, an industry trade publication.
These days munis, as they are called, offer yields that are 85% to 90% of pretax Treasury yields, said George Friedlander, managing director and fixed-income strategist at Salomon Smith Barney in New York. Some munis are yielding as much as 95% of Treasuries, he said.
This makes municipal bonds the better buy for more people further down the income-tax bracket scale, said Steven Chung, an analyst for Morningstar Inc., which tracks the performance of mutual funds. With a typical long-term muni yielding about 5% and 30-year Treasuries yielding about 5.6%, he said, the after-tax yield on munis is superior even for people in the 15% federal tax bracket.
Several factors are behind the rise of munis, including the fact that they lost favor with investors during the bull market in stocks. “Investors for the last three years have snubbed municipals and Treasuries in pursuit of the equity markets and returns averaging 30%,” said David Baldt, manager of the six-year-old Morgan Grenfell Municipal Bond Fund, which has $540 million in assets. “Because of that, the muni market is cheap right now. There’s tremendous value.”
The supply of municipals also is ample as state and local governments have sought to take advantage of the current economy, with its low inflation and generally low interest rates, said Baldt, who was named Morningstar’s fixed-income manager of the year in 1997.
As the number of bonds outstanding rises, issuers have to lower the price to attract buyers. (When the price of a bond falls, its yield rises, and vice versa.) In the first quarter of 1998, outstanding municipal bonds totaled $1.397 trillion, up $29 billion from the end of last year, Beer said.
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Bonds, Yes. But What Kind?
Individual investors have been buying bond mutual funds at an increasing pace during the last two years. But they are mostly reaching for the highest-yielding bond funds, while shunning U.S. government-bond funds. Net new cash flow of key bond fund categories, 1996 through May, in billions of dollars:
High yield: +$38.98
Strategic income: +$23.39
Intermed.-term corporate: +$17.75
Global: --$4.34
Mortgage-backed: --$9.87
Long-term government: --$11.18
Source: Investment Company Institute
