Before the 2008 financial crisis, municipal bonds were fairly simple: You bought a AAA-rated investment, or debt that was insured, and your clients collected tax-free income until the bond matured.
Today that tax-free income is low and fear of default is high, fanned by a string of recent municipal bankruptcies. And insurance plays a much smaller role now that investors have realized that the guarantors can’t make everyone whole in a crisis.
“The municipal market is very fragmented,” says Tamara Lowin, director of research at White Plains, N.Y.-based Belle Haven Investments, a firm that specializes in muni bonds. Lowin notes the name on a bond might make it sound like a high-risk investment, “but once you do a little digging, you realize it’s actually a golden credit.” As an example, she says that some bonds carrying the name “Detroit” are actually backed by Michigan.
Lowin says that buyers have to “look under the hood” of every credit, a big job if you have a ladder of 10 to 12 issues to take advantage of rising rates. Belle Haven and firms like it can provide the credit expertise.
But some advisors don’t like the risk of individual bonds, even if they are picked by pros. Advisor Morris Armstrong of Armstrong Financial Strategies in Danbury, Conn., has a simple strategy for clients in need of tax-free income: “You go into a diversified mutual fund,” he says, to “eliminate the risk of an individual holding.”
The caveat is that most muni bond funds hold long-dated paper to boost yields. “You try to stick to a relatively short duration,” says Armstrong.