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By Jason Stipp | 02-25-2014 12:00 PM

How Enticing Are Munis Today?

As investors realize the impact of new tax increases, municipals are going to become more valuable--but research is key to finding value and avoiding trouble, says Fidelity's Kevin Ramundo.

Jason Stipp: I'm Jason Stipp for Morningstar. It's Tax Relief Week on Morningstar.com. And of course, municipal bonds are an important tool in investors' toolkits when they're looking for tax efficiency. Joining us today to give us a sense of the muni market today and where they may be seeing opportunities is Kevin Ramundo. He is a comanager on Fidelity Tax-Free Bond. That's a Gold-rated fund by Morningstar analysts.

Kevin, thanks for calling in today.

Kevin Ramundo: Thank you, for having me.

Stipp: Kevin, income investors, particularly those in higher income brackets, will take a look at the tax equivalent yields on munis to get a sense of their attractiveness. As you're looking across the muni universe broadly speaking, are the aftertax yields enticing for investors right now given the risks that they would be taking on in the muni market?

Ramundo: Yes. I think we believe aftertax yields are enticing for the investors today. Investors are realizing this, as they fill out their tax forms. In 2013 you had the implementation of a new 3.8% Medicare tax on unearned income. You have higher marginal income rates, and you also have higher dividend capital gains rates. All of these factors have made municipals much more attractive for investors in the highest tax brackets.

We believe at Fidelity that as investors realize the impact of these new tax increases, municipals are going to become more valuable. There are other reasons to own munis. They service a diversifier within the context of a larger portfolio, and they are relatively a safe haven compared to other fixed-income sectors.

Stipp: When you're looking at how those yields have changed over time, have yields gotten better? If municipal securities have been under any pressure--there have been some pressure points in the headlines--what's the trend look like for what you are getting paid for the risk you are taking in munis?

Ramundo: I think generally speaking, yields have widened or gotten higher after the summer when the Fed made their announcement about tapering their bond purchases. So munis became that much more valuable. I think since then we have seen somewhat of a narrowing in that as the market has rallied somewhat in January.

Stipp: Are you using any areas of the muni market that look comparatively more attractive than other areas based on that risk/reward profile or the fundamentals?

Ramundo: Yes. There are. I think at Fidelity the key to finding value among investment-grade munis is doing really good research. There are thousands of muni issuers in our market, and a lot of them don't have notable name recognition or transparency to the retail investors that invest in muni bonds.

In fact, with retail investors, you can't buy AAA [rated bonds] from an issuer anymore. Here at Fidelity, we have a really robust research staff that understands and differentiates these credits. We have a really strong trading desk that pores through our market, and they look to identify value.

If you are going to pin me down, I'd say, one area that we are finding attractive is the health-care sector. Now this might surprise some because the health-care sector is experiencing operating pressures, and many health-care providers are facing regulatory constraints, demand constraints, and competitive constraints. But with uncertainty we believe there comes a great deal of opportunity. We have a very experienced group of health-care analysts, and we leverage them to take advantage of those opportunities.

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