Oct. 4, 2002 — Municipal bond funds, for the most part ignored during the boom years by investors seeking more exciting alternatives, have delivered solid gains this year with equity markets worldwide in disarray.

So far, muni bonds funds have received about $15.2 billion in net new cash through the end of August. That compares to about $10.1 billion for the same period in 2001, according to the Investment Company Institute.

In short, all high-quality muni bond funds have posted gains through the first three quarters of 2002. The average high-quality muni bond fund returned 8.2% for the period. In the third quarter alone, they rose 4%, on average, as stocks sunk. Portfolios with longer-term maturities have done better than their shorter-term counterparts.

“Municipal bond funds have performed well this year because investors are looking for high credit quality,” said Mary Jo Ochson, senior vice president and portfolio manager at Federated Investors. “With all the corporate scandals and accounting irregularities besieging the corporate market, their balance sheets have been seriously weakened,” she pointed out. “Thus, a greater number of investors are seeking `safe assets’ and they can find it in two places: U.S. Treasuries or the municipal markets.”

Ochson noted that munis have a very low default rate, and that about 60% of the muni market is triple-A rated. “This is a very high-quality market that investors feel comfortable going into,” she said, adding that the low interest rate environment has also helped muni bonds. Ochson manages several funds at Federated, including Federated Municipal Opportunities Fund (FMOAX).

Managers have also pointed out that the yields of muni bonds are comparable to those of U.S. Treasuries. John Derek, who runs the U.S. Global Investors Fds:Tax Free Fund (USUTX) and the US Global Investors Near-Term Tax Free Fund (NEARX), finds that as a percentage of Treasury yields, municipals are “very” attractive. “In many cases, you can now go out and buy a municipal bond at the same level that you’d be able to buy a Treasury security at, and you also get the tax benefit that munis offer,” he said. The 10-Year Treasury Yield recently reached a 44-year low of 3.67%.

Derek, too, noted that “in the corporate bond market, you have the hangover from all the scandals surrounding Enron, Tyco, and the telecom blow up. People are looking at the fixed-income area, and see the relative safety of the municipal market from a credit standpoint and from a yield perspective. Munis seem to make a lot of sense when you consider all the alternatives.” However, the manager added that he doesn’t know how long these conditions will prevail, and that interest rates will play a big factor.

Louis Harvey, president of Dalbar Inc., a Boston-based mutual-fund consulting firm, said he is seeing a renewed interest in muni bonds and muni bond funds. “On one hand, they represent a flight to safety; but, more importantly, as interest rates are so low, the spread between the tax-free bonds and the taxable bonds has become so large, that muni bonds are very, very attractive now.”

Harvey added that he doesn’t think any fund company expects the current low interest-rate environment to persist for any extended period time. “A year from now, rates are unlikely to remain at their present level,” he cautioned.

High-Quality Muni Bond Funds

Best Performers2002 Returns Through 9/30/02 (%)Worst Performers2002 Returns Through 9/30/02 (%)

Calvert Tax Free Reserves Long Term Port/A (CTTLX) +13.28JPMorgan Tax Aware Enhanced Income/Select (JPTEX) +0.80

First Investors Insured Tax Exempt II/A (EIITX) +12.37Excelsior Short Term Tax Exempt Securities (USSSX) +1.29First Investors Series Insured Intm Tx Ex/A (FIITX) +12.31Strong Ultra Short Term Muni Inc Fund/Adv (SMAVX) +1.87

State Farm Tax Advantage Bond Fund/A (SFTAX) +12.08Calvert Tax Free Reserves:Limited Term Port/A (CTFLX) +2.44

Harris Insight Fds Tax Exempt Bond Fund/Instl (HXBIX) +11.38Vanguard Short Term TE (VWSTX) +2.62

Source: Standard & Poor’s. Total returns include reinvested dividends. Data as of 9/30/02.