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2 Muni Fund Picks That Sidestep Market Turbulence

Fri, 19 Sep 2014

Fidelity Municipal Income and T. Rowe Price Tax-Free High Yield hold up well when muni markets head south.

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Video Transcript

Kiran Lalani: Municipal-bond funds are divided into short-, intermediate- and long-term categories along with the high-yield muni-bond fund category. There are also state-specific mandates, which are designed to provide tax exemption from a certain state's taxes. Performance in the municipal market is dependent on certain factors, including credit events, changes in bond yields, and other technical factors. Headline risks can also move the municipal market, as was seen in massive outflows in the beginning of 2011 when Meredith Whitney predicted the doomsday scenario for the municipal market.

Long-term muni-bond funds are more vulnerable to valuation declines when yields rise. As was seen in 2013, long-term muni-bond funds lost more money than their short and intermediate counterparts; but conversely, when yields decline, long-term muni-bond funds end up benefiting more, as was seen in year-to-date 2014. A good option in the long-term muni-bond fund category is the Fidelity Municipal Income fund (FHIGX), which has held up relatively well in rough market environments. 

High-yield muni-bond funds invest in the lower-rated and dicier segments of the municipal market. When credit conditions are improving, they benefit because of the higher income and improving credit metrics. But when credit conditions decline, they suffer heavy losses as they did in 2008. Among the high-yield bond funds, a good choice is the T. Rowe Price Tax-Free High Yield muni-bond fund (PRFHX), which did suffer some losses but held up relatively well compared with its peers in the high-yield bond category.

Overall, credit quality has been in a positive trend in the municipal market because of increasing tax collections from an improving economy and spending cuts. The low new-issue supply in 2014 has also supported the market, but there are certain areas of the market that investors need to be careful about--for example, Puerto Rico and Detroit.

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