Are Municipal Bond Funds Still Safe?
Greece and its creditors have come up with a bailout plan that puts the debt crisis tensions at bay at least for some time. However, the Puerto Rico crisis has emerged and should also cause investors to worry. A crumbling economy, massive public debt and increasing government deficit have pushed Puerto Rico to the brink of default, and it wants the right to declare bankruptcy. Puerto Rico owes $73 billion, which it is unable to repay. With their bonds in the junk category now and concerns intensifying, the Puerto Rico crisis may cause a lot of problems for U.S. mutual fund investors. The crisis may particularly affect U.S. municipal bond funds. Governor Alejandro Padilla has stated that Puerto Rico is bankrupt and it is mathematically impossible to repay the creditors. Imposing sales tax in 2006, retrenchment of public employees in 2009, pension reform in 2013, and the latest gas tax and the Sales and Use Tax (IVU) were some of the measures Puerto Rico had been trying to effectively use. Unfortunately, it failed to restrict the country from amassing about $73 billion of debt, which translates into over $20,000 per person in Puerto Rico. This ironically is more than the median income of $19,520 per year. What This Means to the U.S. Though located at thousand miles away from the US, the Puerto Rico debt concern is now becoming a 2016 campaign issue. The larger concern for investors is the exposure to this island. More than 20% of bond mutual funds hold Puerto Rican bonds. Moody’s Investors Service has moved about $56 billion of Puerto Rico’s other bonds into the junk category. It is estimated that around $11 billion in Puerto Rican securities are held by mutual funds. However, U.S. municipal bond funds hold the largest amount of Puerto Rico debt. It was done to benefit from high yields amid the record low rates. Oppenheimer Rochester MD Municipal A for instance has 37% of its assets invested in Puerto Rican securities. Over a just 4-week period the fund is down 3.5% and has lost over 4% in 3 months. Meanwhile, Franklin Double Tax-Free Income A (MUTF: FPRTX ), carrying a Zacks Mutual Fund Rank #4 (Sell), has exposure of 47%. FPRTX is down 3.4% over the past 4 weeks and lost 4.2% in 3 months. According to Morningstar, Oppenheimer Funds’ municipal funds have suffered $2.6 billion worth of investor redemption over the last year. In addition to the exposure, the Puerto Rico crisis may have a domino effect. It will most likely to affect the benchmarks going forward, more prominently than it has in recent days when everyone was busy reading about the drama in Greece. According to Reuters, White House “is not contemplating a federal bailout of Puerto Rico to help the island deal with its debt crisis”. Meanwhile, there is no economic growth in the island. Concerns for the U.S. States Too? The Puerto Rico crisis also reflects on similar problems the US has in hand. Puerto Rico is one territory of the US drowning in debt now. However, there are states that also offer a grim picture. Puerto Rico’s debt as percentage of GDP stands below 70%. But according to a report by the nonpartisan States Project, the percentages for Hawaii, New Jersey and Ohio are 61%, 54% and 51%, respectively. The States Report data also reveal that some states have far larger debt per capita than Puerto Rico’s $20,300. The same for Alaska, New Jersey, Hawaii, Connecticut, Ohio, Illinois are $39,600, $33,800, $33,500, $32,300, $25,900 and $25,200, respectively. States are projected to owe $4.5 trillion. Moreover, there is a $2.8 trillion of debt for local governments. Nonetheless, the local governments have the right to declare bankruptcy. Thus, Congress’ treatment of the Puerto Rico’s crisis will indicate the future of these states. The financial world’s reaction too will decide if the solution, whatever be it, is sustainable for other debtor states. These Funds May Be Safe Options Puerto Rico is in dire need to restructure debt. Its previous measures have failed but the island must strive and may be raise property taxes as well as stop the minimum wage laws. According to a report by former International Monetary Fund economists and as reported by Reuters, “Puerto Rico faces hard times. Structural problems, economic shocks and weak public finances have yielded a decade of stagnation, outmigration and debt… A crisis looms”. While it will be a safer move to steer clear from funds having exposure to Puerto Rico, investors interested in this space may buy the following three muni bond mutual funds. None of the funds listed below feature Puerto Rico securities in their top 10 holdings. These funds either carry a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund. The minimum initial investment is within $5000. These funds are not only in the green so far this year, but have positive total return over the last 1, 3 and 5 year periods. The year-to-date returns may be muted, but they also carry high yield. Dreyfus High Yield Municipal Bond A (MUTF: DHYAX ) seeks high income that is free of federal income tax. DHYAX invests a lion’s share of its assets in municipal bonds. These bonds must offer income that is exempted from federal income tax. DHYAX currently carries a Zacks Mutual Fund Rank #1. Dreyfus High Yield Municipal Bond A is up 0.4% and 6.3% for year-to-date and 1-year periods. The 3- and 5-year annualized returns are 3.6% and 5%. DHYAX provides yield of 4.41%. Western Asset Municipal High Income A (MUTF: STXAX ) seeks tax exempted current income. The fund invests a major portion of its assets in “municipal securities” rated in the Baa/BBB categories or below investment grade. If not rated then the subadvisor determines the fund’s credit quality. STXAX currently carries a Zacks Mutual Fund Rank #2. Western Asset Municipal High Income A is up 0.4% and 4.7% for year-to-date and 1-year periods. The 3- and 5-year annualized returns are 3.3% and 5.5%. STXAX provides yield of 4.31%. Federated Municipal High Yield Advantage A (MUTF: FMOAX ) pursues its objective by investing in a portfolio of tax exempt securities so that at least 80% of the income that it distributes will be exempt from federal regular income tax. Interest income from the fund’s investments may be subject to the federal alternative minimum tax for individuals and corporations (AMT). FMOAX currently carries a Zacks Mutual Fund Rank #1. Federated Municipal High Yield Advantage A is up 0.7% and 6.3% for year-to-date and 1-year periods. The 3 and 5-year annualized returns are 4.7% and 6.2%. FMOAX provides yield of 4.24%. Original Post