INSIGHTS

On February 04, 2011

Municipal Bonds in Portfolios - Two Reasons to Worry, Two Reasons to Seek Guidance

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Over the years, we have heard advisors and investors talk about two primary worries concerning municipal bonds. First, are municipal bonds safe? Second, why and how should I invest in municipal bonds in a rising rate environment?


Of course there is some legitimacy in these two worries. It is foolish to suggest otherwise, or to say cavalierly that everything will be fine. However, as a fixed income resource for advisors, we believe it is our duty to dig deeper and apply our best critical thinking to the challenges that each environment presents. We must calmly assess both the depth of the current problems and the practical likelihood of the most draconian scenarios playing out. There is an old investment saying, “now is always the hardest time to invest,” which suggests that each and every time has its worries and reasons to sit on the sidelines. We believe investors must invest to achieve the goals they have set for themselves. We believe they must work with the markets given to them and stay engaged in order to get where they need to go.


Here are some of our thoughts on the two primary worries concerning municipal bonds today:

1. We recognize that many municipal bond issuers are facing legitimate budgetary challenges; however, we feel these issuers have the incentives and tools to cure their budgetary ills (see "Thousands of Planes Landed Safely Yesterday"). We also see municipal bond issuers across the nation demonstrating their resiliency by making tough budget-balancing choices and instituting necessary reforms.


2. We recognize that there is a reasonable likelihood of higher interest rates down the road; however, we also know that a municipal bond manager can construct and manage a portfolio to help soften the impact of higher interest rates and can help capture those higher rates through targeted reinvestment and appropriate bond swapping (see “Municipal Bond Management in a Rising Rate Environment”).

The municipal bond market is large, diverse, fragmented and difficult for most investors to get their arms around. We believe those who casually paint the entire municipal bond market with a single negative broad brush misunderstand the nature of the market and leave a lot of value on the table for the experienced and diligent to uncover. The very reasons municipal investors are worried right now also happen to be the very reasons professional portfolio managers can be most helpful. You might say that navigating municipal bond credit quality and dealing with a rising rate environment are our bread and butter.


Owning municipal bonds has not exactly been a walk in the park for the past four months, but we believe an appropriately managed municipal bond allocation can continue to perform the critical investment task of garnering tax-exempt income with moderate volatility. It is a challenging time for municipal bonds, but it can also be a time of opportunity, a time to know what you own and a time to seek guidance for your municipal bond journey.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.

An investment in municipal bonds is subject to a variety of risks and investors should consult a financial professional before making any investment decision.