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Two Ideas For Muni Bond Investors Amid A Low Rate Environment - Thursday, 11/08/2012

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Lindsey Bell, Investment Analyst Jim, given Fed actions, interest rates are going to be low for some period of time. Investors have responded by getting into municipal bonds, given their higher yields and higher returns. There's a concern now that those returns aren't going to remain forever. Do you agree with this? What are your thoughts here?

Jim Colby: I think this year, 2012, will be another positive year of returns for munis, but in fact, what has happened is with the decline in nominal rates and the contraction in spreads between different types of municipal bonds, the opportunity to earn terrific returns, or returns beyond what we're probably going to experience in 2012, will be limited and that's a natural result of what's occurred these past two years.

Lindsey Bell: Are there any specific areas within muni bonds that should see better returns beyond 2012?

Jim Colby: I like two areas. One is high yield. I just spoke about credit contraction in the marketplace. The yield of high-yield municipal bonds is nearly 100 basis points above its long-term average, even going back to the early 1990s. At 100 basis points above its long-term mean, high yield presents an opportunity for earning alpha out of a municipal bond product that normally just offers the benefit of the coupon return.

Another area I like is the intermediate part of the investment grade municipal curve. Why do I like it? I like it because the spread in yield between the different maturities — municipal bonds come out in serial maturity structure with bonds that mature 6, 7, 8, 10, 15 years from now — and the difference in yield between those individual maturities are now at a fairly wide margin, which means 20-25 basis points between different maturities. I like this because of what's called the roll down. As bonds mature, as we get through the end of 2012 into 2013, a 10-year bond suddenly becomes a 9-year bond and it gets priced to the 9-year yield, which means an actual pickup in price or an improvement in price for that particular bond.

Those are two areas where I think there is still opportunity for the municipal investor to earn returns above what is normally anticipated with a coupon.

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