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April 01, 2008 at 04:00 AM
When was the last time municipal bond yields were higher than those of U.S. Treasury bonds?
As of March 5, the SPDR Lehman Municipal Bond ETF (TFI) had a 30-day SEC yield of 3.71 percent. The TFI had a tax equivalent yield of 7.02 percent. By comparison, the SPDR Lehman Long Term Treasury ETF (TLO) had a 30-day SEC yield of 4.23 percent.
Under normal circumstances, municipal bond yields are lower than Treasuries because of their tax-free treatment. Income received from munibonds is exempt from federal income tax and from income tax in the state in which they’re issued.
These bond yield discrepancies have recently caught the attention of successful money managers.
During the first week of March, renowned bond manager Pimco scooped up $1.5 billion in municipal bonds. WL Ross & Co., which manages $10 billion, bought up $1 billion in municipal bonds.
What explains the yield discrepancies between munibonds and Treasuries?
The best answer is probably that herd-mentality investors are now more concerned with credit risk than with yields. The current perception is that munibonds aren’t as safe as U.S. Treasuries. As a result, assets have been flooding into ultra-safe Treasury-oriented bonds. This has driven up the price of Treasury bonds and decimated yields.
Despite their yield differences, the average duration of bonds in both TLO and TFI are an identical 11.5 years. Also, the munibonds in TFI have an average credit rating of AA2, which isn’t as solid as government-backed bonds but is still considered strong.
