While some investors are buying, others don't like the uncertainty of municipal bonds.
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By Christine Benz | 02-27-11 | 06:00 AM | Email Article

Is it time to be worried about municipal bonds, or have the recent negative headlines created a buying opportunity in this usually sleepy asset class?

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

Market participants appear divided. Muni bonds took a dive in 2010's fourth quarter owing to several factors: interest-rate jitters, supply and demand concerns, and, at least to some extent, worries over municipalities' financial health stoked by the bearish prognostications of financial analyst Meredith Whitney in a widely discussed 60 Minutes segment. More recently, however, munis have mounted a comeback, indicating that at least some investors must spot value there. For the one-month period through Feb. 23, the typical muni-national fund in Morningstar's database had gained 1.7%, while the average high-yield muni offering had gained nearly 2.0% in that same one-month period--pretty big numbers in this usually slow-moving asset class.

Morningstar users appear to be similarly bifurcated over the future direction of munis, based on your responses to my recent query on the Investing During Retirement forum of Morningstar.com's Discuss boards. While some users are content to stand pat or even add to their municipal bonds at this time, others feel that the many unknowns in the municipal market warrant a more guarded tack. Click here to read the complete thread.

Not Time to Panic
Of the users who posted, the majority noted that the recent news flow regarding municipalities hadn't deterred them from sticking it out with tax-free bonds and bond funds.

Reti59 summed up that sentiment in this post: "I'm not jittery. I like the tax-exempt dividends too much."

Pinky3 is also satisfied to watch and wait. "I am not doing a thing; just holding and compounding tax-free." Jackie wrote, "The compounding is very enjoyable to watch. If I need to tap into the dividends for extra income, I will. For now, I am letting the fund grow."

Nupnup11 is another investor who's standing pat despite some recent turbulence in individual muni holdings. "Approximately 10.0% of my portfolio is in tax-free munis. Those that expire in the near term have increased in value. Those that expire beyond 2020 have lost approximately 6.0%. Average interest 5.3%. My portfolio is all taxable and not used for retirement. I'll just hang on to it unless I really need the cash."

Rkay48 acknowledges that the recent headlines have been unsettling but isn't inclined to cut back on the asset class. "Yes, all the negative hype has made me more nervous. But I hold, one, individual bonds, nearly all AAA or AA; I'm not selling any of these. And two, short-term muni funds:  Vanguard Limited-Term Tax-Exempt  and  Fidelity Short-Intermediate Muni Income ; I'm not selling these either."

Relative to some of the analysts who have recently been weighing in on the muni market, Bitsotree likes the research that professional muni-fund managers bring to the table. "Who is Meredith Whitney anyway? What are her credentials? Maybe she's correct but she fails to provide evidence. Janet Tavakoli shined a bright light on Whitney's lack of credibility. Tavakoli is miles ahead of the TV personalities in terms of intelligence. So are the people who manage municipal bond funds. These managers have more than enough intelligence and experience to avoid pitfalls that exist in the municipal bond market. I prefer to ignore the talking heads and continue to have faith in the folks at Fidelity and Baird who manage my municipal bond funds."

Carman, too, would like to see the pundits face greater accountability: "Because market prognostications are a dime a dozen and seem to contribute a lot to market instability, it would be interesting to see a system implemented to rate the forecasters on the accuracy of their predictions by adding or subtracting stars based on the outcome of their predictions over a fixed (three- or five-year) period. I don't expect that anyone in the analyst community wants to hear this, but a lot of us less sophisticated investors take expert predictions with a grain of salt the size of a small cow lick."

Capecod is similarly disparaging about the prognosticators and thinks the recent headlines have created a buying opportunity for astute investors: "The folks charged with filling airtime and column inches to attract eyeballs to ads have learned that fear sells best. Bank analyst Whitney and outstanding mortgage-backed securities trader Jeffrey Gundlach have gotten lots of attention for themselves and their new firms. However, the considered views of municipal finance- specialist credit analysts and portfolio managers with decades of muni experience and success receive almost no attention. After all, reiterating that AA-ish, geographically diversified muni portfolios, managed by experienced credit analysts and PMs, exhibit superior creditworthiness and offer outstanding risk-adjusted returns is simply no longer exciting enough to count as financial news or to grab those eyeballs for the ads. So, like Gundlach, if you read his words rather than just the headlines, I anticipate there'll be some chi-chi in muni-land as these outstanding assets pass from weak frightened hands into strong ones--as hedge funds and institutional investors exploit a once-in-a-generation investment opportunity."

Holiday has been one of those buyers, writing, "I loaded up on muni's last November. I bought more in January." Windmill3900 also enthused about values in the muni market. "We've been buying individual bond issues for three months. There are great buys if you can find them."

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Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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