Money Management: Those who did yield to the call were rewarded

By Sharon L. Thornton
Posted: 5:25 pm Tue, January 3, 2012

Just over one year ago, the world of municipal bonds, according to Meredith Whitney, would be in chaos with large scale defaults occurring in almost every corner of the country. Those who bought municipal bonds in the first quarter of 2011 should thank Whitney for the opportunity of participating in one of the best performing fixed income asset classes of the year.

Just why did we not see all the defaults that were predicted? States and local divisions are by obligation are fiscally responsible. Current operations cannot be financed by constant borrowing in the market. Most defaults that occur in the tax-exempt market have little correlation to a government’s financing its own activities.

Both state and local governments collect fees or taxes which are spent on owned and operated facilities. The debt service amounts to a minor amount of their annual outlays and is approximately 8.1 percent at the state level and a bit under 14 percent at the local level.

In bad times, spending is reduced to ensure that funds are available for debt service. The larger “bankruptcies” in the market, such as Jefferson Co., Alabama, were a novel of political corruption and incompetency resulting in the possible incarceration of some participants and huge fines on Wall Street firms.

There were huge dichotomies in the municipal market. The first quarter of the year was marked in terms of having more sellers than buyers, where as in the second quarter this was reversed. Buying occurred as both institutional and retail buyers searched for safety and yield outside of the overvalued U.S. Treasury market.

Coming from the extremely cheap level of municipal bonds, there was a greater upside performance than in other fixed-income products, which was recognized by astute investors. The low volume of new issuance of bonds also contributed to performance and in December we witnessed yield levels that had not been seen since LBJ was in office.

Astute professional investors saw the opportunity for inclusion of municipal bonds in accounts that are not tax sensitive, such as retirement or entities that do not play taxes. If you had sold municipals based on the “headline” news or your advisor suggested getting out of the municipal market, you were a double loser!

We included municipal bonds as an asset class across all fixed income investment accounts over the past year and it contributed significantly to our fixed income performance. Headline news creates opportunities for investment. Following the herd mentality can only result in mediocre results.

Sharon L. Thornton is senior director of investments for Karpus Investment Management, an independent, registered investment advisor that manages assets for individuals, corporations and trustees. Offices are located at 183 Sully’s Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.