Sunday Musings: Is It Time To Buy Muni Funds?

Barron’s posted an article about California IOUs along with some thoughts on the possibility of purchasing muni bond funds. Let’s listen in to “California Scheming:”

The outcome of the California crisis ultimately will be determined by politics. As I pointed in the print edition of Up & Down Wall Street a few weeks ago, “Having bailed out the banks and provided a lifeline to Chrysler and General Motors, how does Washington tell California, the eighth-largest economy in the world, to drop dead? That’s the slippery slope that America’s credit rating is on.”

That said, Timothy McGregor, Northern Trust’s director of municipal fixed-income management, writes of California, “We believe that there are ample safe and attractive tax-exempt investment opportunities with the state that allow for diversification. We are finding potential value in unlimited tax general obligations bonds.”

Long-term California state GOs are yielding about 5.80%, equivalent to almost 9% for an investor in a 35% tax bracket and higher still for a Golden State resident paying that state’s taxes.

McGregor adds: “We believe the pronounced weakening of municipal balance sheets during the last two years makes the potential benefits of achieving at a least a portion of many investors’ tax-exempt exposure through mutual funds especially compelling. Mutual funds offer a level of diversification, liquidity and transactional efficiency that even large institutional investors have trouble achieving on their own.”

For instance, the no-load Vanguard California Long-Term Tax-Exempt Fund (VCITX) offers those attributes with a yield of 4.39% and an expense ratio of 0.19%. For the more adventurous, there are California closed-end muni funds.

According to etfconnect.com, California closed-end funds sell at discounts to net-asset value of as much as 17%, which is exceeded only by a handful of Michigan closed-end funds. (Closed-end funds trade at a discount or premium to their NAVs on stock exchanges depending on their demand and supply in the market.) And as parlous as the conditions in California, they’re not as bad as Michigan’s.

Yields of as much as 7% are available from a variety of California closed-end muni funds trading at discounts of about 15%. On a taxable-equivalent basis, that’s equal to the double-digit yields on corporate junk bonds. But the high yields are the result of leverage in the funds, which boosts their risks.

All in all, California closed-end muni funds offer the potential for equity-like returns, albeit with undeniable risks, but arguably less than stocks’. And they could get still cheaper if the state’s fiscal crisis worsens and nervous holders dump anything with California in the name. That would be the time to pounce.

The last sentence says it all. Munis could get cheaper, and you really are put in a position to try to pick a bottom if you consider these investments.

My personal view is far less enthusiastic. I don’t think much of bottom picking to begin with. However, more importantly, we are entering unchartered territory when it comes to State and municipal deficits along with severe budget problems. Potential bankruptcies are certain to become a viable option.

What good does a high yield do, if you lose far more on the principal side, which is exactly what happened last year?

In terms of deficits, things have gotten far worse since then, and no one knows if a bottom is even on the horizon. I don’t like to bet on totally unknowns in the hope that I might get lucky. I will stand aside on this one.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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