Contrary to the recent bad press municipal bonds, when chosen carefully, can provide security, tax breaks and income, industry experts said.
Headlines predicting widespread defaults in loans to state and local governments frightened consumers into a steep sell off of some $35 billion in mutual bond funds since November, but bond specialists say the media exaggerated the risks.
“The municipal market is a rock solid credit,” said Brian King, product sales specialist for the investment firm Gannett, Welsh & Kotler LLC. “It is the greatest credit outside of the U.S. Treasury.”
About 70,000 municipalities participate in the $2.9 trillion municipal bond market, but only 54 municipal bonds gone into default since 1974, King said Tuesday at a fixed-income forum sponsored by the wealth-management company Concord. In the highly publicized bankruptcy of Vallejo, CA, it’s important to note the city did not default on its loans, said King, adding “There’s a difference between bankruptcy and default.”
California, the most debt-ridden state in the union, uses only 6 percent of its budget to finance interest on municipal bonds, King said. Most municipalities will use 3 percent to 5 percent of their budgets to finance municipal debt.
Investors who diligently research the credit quality of bond issuers can benefit from the advantages of muni funds, King said. He recommends investing in bonds issued by states - which cannot declare Chapter 9 bankruptcy - and by large cities. King advocates shying away from bonds issued by small towns, which are vulnerable to state budget cuts and declining revenue from taxes on property, sales and businesses. More than three-fourths of defaults involved loans to health and housing agencies, which are considered a riskier sector for muni bonds.
“You have to know what you own and what’s backing it,” King said.
The municipal market does not receive the same media scrutiny given to stocks, King said. The market may be difficult to follow because it is extremely segmented and reporting requirements are not as stringent as those for equities. There is no central exchange for municipal bonds, and the products divide into numerous categories based on maturity date, region and type. Still, retail investors willing to do their homework can add municipal bonds to their portfolio to gain security, tax advantages and some income.