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By Christine Benz | 12-07-2010 01:29 PM

Why Are Muni Bond Funds Struggling?

Morningstar's Miriam Sjoblom explores why muni bond volatility has ticked up over the last month.

Christine Benz: Hi, I am Christine Benz from Morningstar.com. The bond market struggled during the month of November and municipal bonds were no exception. Here to provide some context behind these headlines is Miriam Sjoblom, she is Associate Director of Mutual Fund Analysis for Morningstar. Miriam thanks so much for joining us.

Miriam Sjoblom: Thank you, Christine.

Benz: So there have been some really scary headlines recently municipal bonds did have a tough month, let's talk about some of the key factors that drove municipal bond funds down recently.

Sjoblom: Well sure, one of the biggest ones affected bond funds generally and that is after the Fed announced its QE2 program. Some market participants may have been speculating well now that the Fed is trying to stoke inflation what's that's going to mean for long maturity yields. So, that could have caused some of the price declines for long maturity munis.

Benz: That's one thing that you noted that it was one of the hardest hit categories during the period?

Sjoblom: That's right. Funds in our national long term muni category lost around between 2% and 5% during the month of November.

Benz: Okay, so it sounds like also within the muni market some supply demand imbalances may have driven the securities down as well?

Sjoblom: Sure. In this the supply and demand imbalance, supply is not necessarily, this isn't unique to 2010. Supply tends to be heavier in the fourth quarter of the muni market. We saw about 3 billion to 5 billion a week in issuance this summer. During November one of the most, the first difficult month it was expected that about 12 billion would come to market.

Benz: So that was another factor depressing the prices?

Sjoblom: That's right.

Benz: One thing I want to talk about, there has been a lot written about whether credit qualities and municipalities struggles have contributed to this dip in muni prices, what's your take on that issue?

Sjobolm: Well, I mean it's a very good question. You know for starters, in another part of the supply and demand imbalance was that retail investors pulled money out of mutual funds to a very large degree. And it could be that all of the negative headlines about credit quality could have, in addition to some price volatility could have prompted some retail muni investors to take their money out. Retail investors are a huge part of the municipal bond market. It's a little different from the taxable bond market where retail investors own about two-thirds of the municipal bonds markets. So it could have an effect on impacting investors' perceptions.

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