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By Christine Benz and Eric Jacobson | 02-26-2014 01:00 PM

Do You Understand What's in Your Muni Fund?

Morningstar's Eric Jacobson breaks down the nuances of GO, revenue, and tobacco bonds, warns about a yield pitfall to avoid, and offers best practices for researching muni fund portfolios.

Christine Benz: I'm Christine Benz for Morningstar.com.

It's Tax Relief Week on Morningstar.com, and municipal bonds are an important part of many investors' taxable portfolios.

Joining me to share some tips for assessing what's in your muni fund is Eric Jacobson. He's is a senior fund analyst with Morningstar.

Eric, thank you so much for being here.

Eric Jacobson: Christine, great to be with you.

Benz: Eric, one of the big divisions in municipal bond land is between what's called general obligation bonds and revenue bonds. Let's talk about those two different categories and how investors should look at them.

Jacobson: As you say, these are two very big catch-all categories. I say that because there are certainly nuances underneath in terms of structures and guarantees that certainly are a little different from bond-to-bond and type-to-type underneath those big umbrellas.

But the general idea is that general obligation bonds are essentially backed by the full faith and credit of the issuer--very often a state, for example, or it could be another municipality. Effectively what they're saying is, it doesn't really matter where we get the revenues from, what kind of taxes, we're going to put you first and promise to back your debt with our full faith and credit.

Whereas, a revenue bond is set up specifically to channel the fees and revenues of a specific project, or a facility perhaps, that will fund the principal and interest of those bonds in such a way that even if the municipality that is associated with it runs into its own financial difficulties, you as the lender have the advantage of knowing that as long as the revenue-generating entity that's backing those bonds is in good stead and operating properly--especially if it's something really essential like a water treatment facility or something else where you know that it's going to be the last thing to ever get cut--then you know you can rely on that a little bit better.

Historically, I think a lot of people have favored general obligations over revenues, but that's changing a little bit because of things going on.

Benz: I wanted to ask you about that, because I think a lot of people do assume that those general obligation bonds are safer than other types of municipal bonds. Is that always the case?

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