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December 20, 2004 at 07:00 PM
Dec. 16, 2004 — Rising interest rates have spurred investors to abandon some bond mutual funds this year, but one group of fixed-income investments — high-yield municipal bond funds — has continued to attract money.
Funds that buy these securities have turned in good results so far, and that should continue in 2005, if interest rates move up gradually, money managers say.
High-yield municipal bond funds took in about $2.5 billion through October this year after netting approximately $2.8 billion in all of 2003, according to Financial Research Corp. Cash inflows into these funds increased each year between 2001 and 2003 after they suffered outflows in the previous two years.
Investors this year have pulled money out of funds that invest in other municipal bonds, notes Sam Campbell, an FRC analyst. Funds that invest in government bonds had also hemorrhaged cash through the first ten months of the year, FRC says.
Investors have been drawn to municipal junk bond funds by their relatively high yields, which have looked particularly good while interest rates remain low, money managers and others say.
“I think what you’re seeing is that, in this low interest rate environment, investors have been seeking any additional yield they can find, and one of the ways to do that is to go down the credit spectrum,” says David Kerwin, portfolio manager of the AXP High Yield Tax Exempt Fund/A (INHYX). That fund buys medium and high-quality municipal bonds and keeps a small portion of its assets in lower-rated municipal bonds to help boost yields.
The average high-yield municipal bond fund was up 4.6% this year through November, and 5.3% for the 12 months ending that month. By comparison, funds that invest in intermediate term U.S. government bonds gained 2.5% and 3.2% during those periods; funds that buy intermediate term investment-grade corporate bonds and U.S. Treasurys returned 3% and 4%.
Regardless of their performance over the short term, high-yield municipal bonds offer a number of benefits, observers say.
To start, unless an investor is subject to the alternative minimum tax, income on these bonds is tax-free, which can be especially beneficial for someone in a high tax bracket.
“People look at them for tax-exempt income; that’s one of the primary” advantages of investing in the sector, says Jane McCart, who manages the Northern High Yield Municipal Fund (NHYMX).
