The troubles in prosperous Orange County have investors around the country worried that any municipal bond -- or bond fund -- could turn into a lemon. But all that worry just may give opportunistic investors a chance to make lemonade.
Last Tuesday's bankruptcy announcement, and the subsequent radical downgrading of Orange County's creditworthiness ratings by major rating companies, quickly reversed what had been a healthy, several-week-old rally in muni-bond prices. The Bond Buyer municipal index skidded to a 1.3 percent loss between Wednesday and the end of trading on Friday as investors suddenly decided that munis were not the place to be.
Owners of California bonds were hit hardest, of course. Share prices of single-state, California closed-end muni-bond funds dropped by an average of 5 percent for the week. (Closed- end-fund shares are listed on stock exchanges and trade through brokers like stocks.)
Such losses don't portend catastrophe, however. In fact, they were enough to have muni-bond professionals sniffing the air for bargains. "This is a great opportunity to buy high-quality municipal bonds," says Jim Lynch, editor of the New York-based Lynch Municipal Bond Advisory newsletter. Instead of focusing on Orange County, Lynch says, investors should consider muni bonds' relatively high yields and low supply, buy selectively, then hold on for the long term -- sidestepping the day-to-day price fluctuations that vex professional traders. At the start of the year, a typical, AAA-rated, 10-year muni bond yielded less than 4.5 percent, he points out; now the same bond yields about 6 percent (and that yield is exempt from federal tax). A slowdown in new bond issues, Lynch notes, should pinch supplies for at least the next year, keeping prices strong.
Bargain time? Closed-end-fund expert Thomas Herzfeld of Miami-based Thomas J. Herzfeld Advisors agrees that muni bonds' "fundamentals" look strong but thinks prices may look even better -- that is, lower -- in a week or two. For one thing, he says, many individual bond-fund investors -- unlike professional traders -- haven't had time to digest last week's events and decide whether to stay in or get out. Starting this week, he thinks, many will get out. "I still expect year-end, tax-related selling, selling pressure from concern over the Orange County bankruptcy and selling from general uncertainty over interest rates," says Herzfeld. Assuming prices slip further this week and next, he adds, "It will be a good chance to buy. It's bargain- hunting time." Herzfeld has identified several dozen closed-end funds he thinks will dip low enough by year's end to make them worth buying; for a half-dozen examples, see the table.
Bill Vlahos, a partner at San Francisco-based Wetherby Asset Management, also expects prices to dip further in the next few weeks as more individual investors bow out. But by January, he says, the Orange County fallout should have settled, and he expects to start moving his clients into several intermediate- term, open-end muni-bond funds (three of Vlahos's picks are listed in the table). Consider buying then, he says, as long as prices haven't risen more than 3 percent from current levels.
A bankruptcy with a silver lining
Orange County's troubles could create buying opportunities in municipal bond funds. Two experts' suggestions: In January, consider the intermediate-term, open-end funds below; or, as soon as prices meet or beat the targets, the six closed-end funds, which trade like stocks.
Change from
Dec. 9 previous Buy at or
price week under... OPEN-END FUNDS (phone no.)
Dreyfus Intermediate Muni. Bond $13.09 -0.5 pct. $13.48 (800-645-6561)
Fidelity Limited Term Municipals $8.93 0.0 pct. $9.20 (800-544-8888)
Sit Tax-Free Income $9.43 0.0 pct. $9.71 (800-332-5580)
CLOSED-END FUNDS
BlackRock Calif. Insured 2008 Term Trust $12.50 -5.1 pct. $11.75
MuniVest California Insured $10.63 -2.3 pct. $9.75
Nuveen California Municipal Income $10.75 -3.9 pct. $10.50
