Quick Take:The $14.7-million Lebenthal Taxable Municipal Bond Fund is an oddity among fixed-income portfolios: It is not a typical municipal bond fund, since the interest income from muni bond funds is usually, by definition, tax-free; nor is it a corporate bond fund, since it doesn’t invest in corporate securities.
Regardless of how the fund is classified, it has performed extremely well. Year to date through September 30, the portfolio gained 14.6%, making it the best performer among muni bond funds for the period. It was also a top performer, both on an absolute and risk-adjusted basis, for the three years ended in September, with an average annualized return of 12.4%. The average national long-term muni bond fund, in comparison, returned 7.2% for the same three-year period.
The portfolio is currently the only one of its kind in the mutual fund universe. The Heartland Taxable Short-Duration Municipal Fund, which was the only other taxable muni bond fund, was put into receivership by federal regulators for regulatory infractions.
While the Lebenthal Taxable Municipal Bond fund began operations in December 1993, Gregory Serbe has been lead manager since April 2001. He served as assistant portfolio manager from 1998 to 2001. The fund has carried a 5-Star ranking from Standard & Poor’s since September 2001.
The Full Interview:
S&P: What exactly are taxable municipal bonds?
SERBE: Taxable munis arose from various federal tax law changes starting in the early 1980s. The federal government decided it would both regulate the muni bond market, as well as limit the types of tax-free municipal bonds that could be issued; that is, those bonds which financed activities that are beneficial to the general public. The federal government will not subsidize the financing of certain activities, such as investor-led housing and industrial projects, local sports facilities, or the funding of a municipality’s underfunded pension obligations.
Taxable munis can be used to advance refund tax-exempt issues in situations where the tax laws prohibit a tax-free advance refunding. Probably their greatest advantage is the issuer’s ability to earn and keep arbitrage profits that are connected with a taxable issue. This makes taxable bonds very attractive for funding pension fund liabilities.
S&P: What is the size of the market?
The taxable municipal market has grown phenomenally in recent years — about $75 billion in taxable municipals have been issued in the past five years. Along with increased investor interest has come both an increase in liquidity, and a tightening of spreads.
S&P: How do you run this portfolio?
SERBE: From an overall strategic view, we manage for total return; thus we’re not only looking at the juiciest yields. We place a premium on high credit quality and liquidity. We also look at the shape of yield curve to find where the best values are.
S&P: Is your fund the only open-ended taxable municipal bond fund?
SERBE: Yes. As far as we know, we are the only one.
We are typically classified as a corporate bond fund because the interest income from taxable municipal bonds is taxable on a federal level. However, there are certain states that exempt some of their taxable municipal bonds from state income tax. With all other things being equal, a municipal bond with a state tax-exemption will have a slightly higher price and lower yield than a municipal bond, which is subject to both federal and state taxes.
S&P: What are the fund’s top sectors?
SERBE: As of Sept. 30: the largest sectors were general obligation, 24.7%; housing, 11.4%; airport revenue, 10%; pension, 6.9%; education, 6%; health care, 5.9%; stadium, 5.8%; federally insured hospital, 5.5%; dedicated tax, 4.8%; long-term care, 2.9%; lease back, 2.7% and tobacco, 2.4%.
S&P: What are the fund’s other statistics, including current average yield?
SERBE: As of September 30, the fund’s average coupon was 7.4%; current average yield, 5.6%; average maturity, 10.9 years; and average duration, 6.8 years.
Taxable municipal bonds tend to have higher yields than tax-free municipals because, among other things, the income is federally taxable, whereas the interest income from traditional municipal bonds is federally tax free. Because of this, taxable municipal bonds, like corporate bonds, trade on a relationship to the U.S. Treasury market.
S&P: Who purchases taxable municipal bonds?
SERBE: The buyers of taxable municipal bonds tend to be investors in a low-tax bracket, like retirees, or those looking for fixed-income investments for their retirement accounts.
Interestingly, over the past couple of years, large insurance companies that have traditionally purchased corporate bonds have started putting money into taxable municipals because they are becoming increasingly concerned with the event risk associated with corporate bonds, given the disastrous recent events with companies like Enron and WorldCom.
If a municipality gets into trouble, unlike a corporation, its services and infrastructure may be taken over by another entity. Obviously, a city cannot disappear. For example, when New York City got in trouble in the 1970s due to over borrowing, the State of New York formed the Municipal Assistance Corp., which prevented the city from going bankrupt.
S&P: What is the fund’s credit profile?
SERBE: As of Sept. 30, 79.45% of the fund’s assets were invested in AAA-rated securities; 15.58% in AA, and the remaining 4.97% in A.
S&P: What are some of the advantages of investing in taxable municipals?
SERBE: The advantages depend on your tax-bracket, and on the spread relationship between the taxable municipal bonds and tax-free municipals. Let’s say you’re in the maximum federal, state and local tax bracket which, here in New York City, amounts to about 45%-50%. If you can buy a Treasury at 5%, a taxable muni at 6%, and a tax-free muni at 5% (all with similar maturities), the best buy for you would actually be the tax-free municipal. However, if this investment was for a retirement account, the taxable municipal bond would probably be more appropriate.