From the September 2008 issue of Boomer Market Advisor • Subscribe!

10 Questions for: George Strickland, Managing director and head of municipal bonds, Thornburg Investments

Given that municipal bonds are offering return potential as attractive as stocks, with much less risk, we thought we'd give them a hard look. But the bond insurance issue gave us pause. Is it a serious problem for muni investors, or much ado about nothing? We turned to George Strickland of Thornburg Investments for help. Strickland discusses the state of the municipal bond market and the role that high profile problems at many bond insurers are - and should - play in investment decisions.

1. Boomer Market Advisor: Why is the market a bit skittish of municipal bonds at the moment?
George Strickland: A number of reasons; first, there is the downfall of bond insurers, in some cases they've dropped below investment grade. Also, the muni market got addicted to a AAA-rating stamp of approval. AAA on a private institution is far different from a government-backed muni. So bonds now are trading on the fundamental value of their underlying credit.

2. BMA: Which means?
GS: It's inexpensive on a relative basis, but a bit frozen because of the uncertainty concerning bond insurers.

3. BMA: How concerned should we be about the insurance angle?
GS: Even without insurance (which I believe there is an over-reliance on among investors), I still consider munies attractive because of extremely low historic default rates, a relatively low risk level and the fact that munies' tax exemption isn't priced into them.

4. BMA: And what role does the credit crunch play?
GS: Well, with the credit crunch, two of the major institutions are out of the business: Bear Stearns and UBS. So there's less trading power and less interest on the buy side. Hedge funds, for instance, are over-leveraged.

5. BMA: What the near-term prognosis for municipal bond performance?
GS: Municipal bonds are set to outperform treasuries; I don't know about other asset classes, but definitely treasuries. Moody's will go to rate munies on a global scale, similar to how they rate corporate bonds. Default rates are 2 percent for corporate bonds versus 3/10ths of a percent for munies.

6. BMA: What do you think will happen?
GS: So Moody's will either upgrade munies or have to downgrade corporates in order to make it more of an apples-to-apples comparison.

7. BMA: How will the election cycle impact the munies market?
GS: Tax rates are almost sure to go up no matter who wins the White House. As a result, we expect muni inflows to rise.

8. BMA: So it will positively impact the municipal bond market?
GS: Before the latest tax cut, munies traded at or below 80 percent of treasuries on a yield basis. They now trade at 90 percent or 100 percent on a comparative yield. A tax increase will cause their yield to return to the 80 percent level. So, due to the inverse relationship between price and yield, there will be solid price support for the municipal market. Treasuries are overpriced, yields are too low, so I believe munies will outperform.

9. BMA: What recommendations do you have for muni placement within the portfolio?
GS: As advisors, if you always watch your maturities, use a laddering approach to bond investment and use high-grade corporate bonds, you'll be all right.

10. BMA: So munies should be a large part of a high-net-worth individual's portfolio?
GS: It certainly is in mine.

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