Retail investors ignored the pullback in the state and local government debt market last week, committing the third-heaviest slug of new money to municipal bond mutual funds this year.

Investors during the week ended Sept. 9 entrusted $932.6 million to municipal funds that report their figures on a weekly basis, which represent more than two-thirds of the muni fund industry, according to Lipper FMI.

All muni funds, including those that report their figures monthly, have been posting average inflows of $1.09 billion a week the past four weeks.

Numbers from the Investment Company Institute show that August was probably the heftiest month for municipal fund inflows since February.

After setting the record for new money last year, mutual funds are on pace to register the second-heaviest annual inflow this year. For most of the summer, municipal mutual fund inflows escalated in concert with a scorching-hot municipal bond market.

Demand for safe investments and expectations for a prolonged period of low interest rates propelled munis to unprecedented heights.

The yield on the benchmark 10-year triple-A muni shaved 62 basis points from the end of April through the end of August, according to the Municipal Market Advisors scale.

Municipals delivered returns at an annualized rate of more than 14% during that period, based on the S&P AMT-Free National Municipal Bond Index.

The Municipal Market Data scale, which runs back to the early 1980s, hit all-time lows at every major maturity. Mutual fund flows followed suit.

The four-week average for inflows dipped in May to the lowest level since the beginning of 2009. After the Greek sovereign debt crisis sent high-quality fixed income on a tear, flows picked up again. Flows remained strong last week even as the underlying bonds sold off.

Municipal funds that post their figures weekly reported market losses of $816.5 million last week to post their first loss since June.

Municipal bond prices have dipped 0.6% so far this month, according to the Standard & Poor's index.

The irony is that this backup came during a week with a pittance of new supply. Municipalities sold just $2.64 billion in new debt last week - an amount that was unlikely to threaten the supply-demand balance.

"It happened during a time when the Street was pretty light in inventory," said Rick Taormina, a managing director and portfolio manager at JPMorgan Funds. "It was simply rates at levels [that] folks think have just gone too far. A lot of folks had started to build up some more cash because the opportunities out there were just not available."


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