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Puerto Rico Bonds May Be Hiding in Your Clients’ Portfolios

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Advisors who have invested clients’ funds in municipal bond funds or ETFs need to check if those investment vehicles own Puerto Rico government bonds, which are now trading around 64 cents on the dollar. Investors may have exposure to those bonds without even knowing it.

Oppenheimer Rochester New Jersey Municipal Fund (ONJAX) has close to 30% of its assets invested in Puerto Rico debt and the company’s Fund Municipals (RMUNX), a New York state muni bond fund, has roughly the same percentage of Puerto Rico bonds.

 “The most important thing an advisor or investor can do is look inside their portfolio,” says Todd Rosenbluth, director of ETF and mutual fund research at S&P Capital IQ.

The two Oppenheimer Rochester funds mentioned above are investment-grade funds, which are less likely to hold Puerto Rico bonds than high-yield bond funds. Among high-yield muni funds or ETF, “There’s a good chance they have exposure to Puerto Rico,” says Rosenbluth.

Market Vectors High Yield Municipal Index ETF (HYD) has a 3.2% exposure to Puerto Rico debt; Market Vectors Short High-Yield Municipal Index ETF (SHYD) has a 4.5% weighting, and SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB) a 14% weighting, according to Rosenbluth.

Many muni bond funds and ETFs hold Puerto Rico debt because they have relatively high yields and because they are triple exempt. The interest they pay is not subject to federal, state or local taxes. But these bonds have become a very risky investment because the finances of Puerto Rico have become very problematic.

“The question now is how bad will the losses be when they occur, not so much if they occur,” says Michael Comes, a portfolio manager at Cumberland Advisors. He says the market is now predicting Puerto Rico will be able to pay roughly 50 cents on the dollar, which would be “a larger haircut for bondholders than Detroit [and] “the largest restructuring in municipal history.” 

The governor of Puerto Rico, Alejandro Garcia Padilla, said Monday that the budget gap of the commonwealth is bigger than previously thought and Puerto Rico will not be able to repay its $73 billion of debt. He said the U.S. territory needs to declare bankruptcy in order to restructure its debt, but bankruptcy is not an option for Puerto Rico under current law, and at this point it doesn’t appear that the White House or Congress is willing to change the law.

On Tuesday, S&P said default by Puerto Rico was inevitable and cut the rating of Puerto Rico’s debt two notches to CCC-minus from CCC-plus.

The downturn in Puerto Rico bonds is also taking its toll on municipal bond insurers MBIA and Ambac Financial and could potentially impact municipal bond funds that don’t hold Puerto Rico bonds if the mutual fund companies have to sell other bonds in order to meet redemptions.

— Check out Munis Meet Milken as Hedge Funds Dictate Puerto Rico Terms on ThinkAdvisor.