Municipal Bonds: Two Muni-Bond Fund Investment Opportunities

At the beginning of 2009, institutional and individual investors were sitting on a mountain of cash, pulling money out from everywhere - including equities, commodities and municipal bonds. That’s nearly $9 trillion, according to the Federal Reserve.

But those same investors are starting to unleash a landslide of cash into the markets. According to the April, 2009 Merrill Lynch Survey of Fund Managers, optimism about global economic growth has reached its highest level since 2004, prompting investors to lower their aversion to risk.

The percentage of investors who are overweight in cash in their accounts fell to 28% in April from 41% in March. That’s a significant drop, and it represents a lot of cash being put to work elsewhere.

Those numbers make sense, according to AMG Data. The $3.7 trillion money market fund sector experienced cash outflows of $35.5 billion in February, $51.15 billion in March, $18.7 billion in April and $15.2 billion so far in May.

Why? Investors’ aversion to risk is waning, and they are beginning to feel comfortable again putting money into riskier investments. So where’s all this cash going? That depends somewhat on whom you ask, but the short answer is just about every place it came out of last fall, including municipal bonds.

Gary Baker, co-head of international investment strategy at Banc of America Securities-Merrill Lynch Research, recently remarked, “Improving sentiment on financials has decisively removed the log jam on sector rotation, prompting a march out of defensives into cyclicals.”

And it’s just getting started, according to Michael Hartnett - Gary Baker’s partner at BOA: “It’s important to note that asset-allocators are still underweight equities, indicating they have yet to fully embrace the idea of a new bull market.”

One place they are embracing the bull market idea, however, is China, where investor bullishness is at a six-year high: “Investors looking to play the global recovery are using China and other emerging markets, rather than Europe or Japan, to do so,” Harnett said.

Opening the Financing Floodgates Into Municipal Bonds

Perhaps the most interesting place money appears to be flooding into is one area that sorely needs it: the municipal bond market.

In the midst of the financial crisis in the fourth quarter of last year, money was drained from the muni -bond market - and the 1,728 mutual fund share classes that invest in them. Investors pulled out $9.42 billion and market losses slashed another $$42.3 billion from the sector.

That was a tough time for many state and local governments, who rely heavily on municipal bonds to finance many large capital-intensive projects like schools, water and sewer plants, and hospitals.

Jed McCarthy, managing member of 1861 Capital Management, said, “People forgot ‘munis’ were safe credits.”

Well their memories have apparently returned: Investors are shoveling money back into municipal bonds at record rates - to the tune of $1.73 billion per week - according to AMG Data.

As a result, the muni market is appreciating once again, regaining $23.4 billion so far in 2009. Great news for investors and governments alike.

Newfound Interest In Municipal Bonds Has Staying Power

This newfound interest in municipal bonds will likely have staying power. The reason? Investors - many of whom were burned big time in the stock market last year - are looking to reinvest, but want a safer alternative than stocks.

They’re not ready for a full-on charge into equities just yet…

They are finding it in municipal bonds. Right now, 30-year munis (according to the Municipal Market Date-Line yield curve) offer a tax-exempt yield of 5.19%. This translates into an equivalent taxable yield of 8.5% (assuming Obama’s proposed top tax bracket of 39%).

As far as municipal bond funds go, there are literally hundreds of them. You can buy funds that contain bonds from nearly every state in the union, and most brokerages offer general, closed-end municipal bond funds as well.

iShares S&P National Municipal Bond Fund ETF (MUB) and the SPDR Barclays Capital Municipal Bond ETF (TFI) are two good ways to cover the entire space.

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