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By Jeremy Glaser | 04-11-2013 11:00 AM

Avoiding Potholes in Municipal Bonds

Although some opportunities are available today, muni investors should be sure they are getting compensated for the risks they are undertaking, says Fidelity's Mark Sommer.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

I'm joined today by Mark Sommer, he is the portfolio manager of several Fidelity municipal bond funds. We're going to look to see what kind of values there are in the municipal sector, and what risks investors should keep in mind.

Mark, thanks for joining me today.

Mark Sommer: Thanks for having me.

Glaser: So let's talk a little bit about muni credit risk first. This was something that was really high on investors' mind for a while, and it's re-emerged with the bankruptcy in Stockton and with potential municipal woes elsewhere. How concerned are you about credit risk, and is this an even concern when you look across the different sectors of municipal bonds?

Sommer: Jeremy, it's definitely out there. I think that in Stockton, the issue there is whether or not they are going to pay pensions at the expense of bond holders, and then at the other end of the spectrum in Rhode Island, the state actually passed legislation to protect GO bondholders, and that came into play in Central Falls bankruptcy. And while you could have a resolution in Stockton that could set a precedent for the rest of the state, it's not clear at all that this would carry over to other states.

So, one of the underlying themes--both in Stockton, Illinois, Puerto Rico--is the underfunding of pension liabilities. One of the silver linings here is that pension reform is finally gaining some momentum, both at the state and local level. I think from an investor's standpoint, the key will be avoiding the most troubled credits. We don't expect there to be waves of defaults or restructurings, but there are definitely going to be potholes to avoid.

Glaser: So it sounds like those credit issues will be relatively contained. You mentioned California being a potential issue, Illinois, and Puerto Rico, are there other areas that you're avoiding for credit reasons?

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