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By Christine Benz and Elizabeth Foos | 02-18-2016 12:00 AM

6 Elite Muni Funds

Morningstar's Beth Foos shares some of our top picks for tax-sensitive investors seeking short-term, longer-term, or high-yield muni funds.

Note: This video is part of Morningstar's February 2016 Tax Relief Week special report.

Christine Benz: Hi, I'm Christine Benz for It's Tax Relief Week on Joining me to discuss some of Morningstar's favorite municipal-bond funds is senior analyst Beth Foos.

Beth, thank you so much for being here.

Beth Foos: Thanks for having me.

Benz: Before we get into some of the specific funds that you and the team like, I'd like to talk about the case for holding municipal bonds inside of a taxable account. What are the tax advantages of doing that?

Foos: Well, muni bonds are most attractive for folks who are looking to manage the tax consequences of their investments, primarily because the interest earned on muni bonds is generally free from federal income taxes. Depending on where that investor lives, muni bonds can also be free from state income taxes and local income taxes as well.

Benz: So, if I live in California and I'm buying California bonds, I'll get the national tax break and then I may also get the state and local tax break, too.

Foos: Absolutely.

Benz: Let's get into the performance of munis before we get into the specific funds that you want to talk about. Performance has been really good.

Foos: Sure.

Benz: When I look across, year to date, through mid-February or the one-year trailing returns, every single muni category is in the black. What has been driving that? That's better than is the case for the taxable-bond categories, where you have various categories that have sunk.

Foos: Absolutely. Munis actually fared relatively well through the rocky markets of 2015, and that has also remained true in 2016. I think it was actually one of the top-performing fixed-income asset classes for 2015 and is doing, again, as you said, very well in 2016. I think that's primarily because we've seen some of the larger issues that were weighing down the taxable-bond and equity issuers, such as the decline in oil prices or the general concern over slower economic growth primarily in emerging markets, just don't impact muni issuers as directly or as significantly or immediately as they do some of those other issuers.

We saw a lot of that market volatility in the corporate-bond and equity space cause some flight to quality for investors, especially in the second half of 2015. Munis have always been regarded as a higher-quality, lower-volatility sector. So, we saw a lot of inflows into muni funds; at the same time, issuance was kind of flat or lower than historical levels.

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