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Municipal Bonds Offer Opportunities, RidgeWorth Paper Shows

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According to a white paper released by RidgeWorth Investments, the high-grade municipal bond market still offered attractive opportunities for investors, even though the market was dramatically different from last year, when “high-grade municipal bonds offered investors an extraordinary opportunity to obtain yields at a historically high ratio relative to Treasuries.”

The May 2010 white paper enumerates four chief reasons it says drove up the prices of municipal bonds in 2009, and says that it expects those same reasons to continue to figure prominently throughout 2010: budget and credit problems, increased tax rates, Build America Bonds (BAB), and low money market yields.

The tax-equivalent yield of municipal bonds can prove advantageous, it says, not just to wealthy investors but also to average investors. It offers a link to an interactive chart that compares the tax-equivalent yield on municipal bonds across select income levels since 1991.

Citing five key benefits of investing in munis – tax-free income, low default rates, low price volatility, diversification, and attractive total returns – the white paper also looks at the return to long bonds, stimulated by the near-zero interest rate as investors seeking higher yields try to lock in returns for longer terms, and suggests that there may be a rush to invest in BAB as 2010 draws to a close. BAB, unless extended, expires at the end of the year; if it is extended, there is speculation that the subsidy rate will drop from 35% to 28%.

There is, of course, the potential for problems because of budget and credit problems in municipalities as they struggle to keep up with tax rate caps, lower collections on personal income and sales taxes, and drops in home values; however, the paper says, “no evidence of an unusual amount of municipal bond downgrades has surfaced during the first quarter 2010, with the exception of a few well-publicized states.” Indeed, higher tax rates are expected to offset shortfalls, which will, says the paper, result in “a higher taxable-equivalent yield” for all tax-exempt bonds, “and bonds sold in the future will sell at higher prices than if taxes had not increased.