Munis' Wild Ride

Miriam Sjoblom: Hi, I'm Miriam Sjoblom, a mutual fund analyst at Morningstar. I'm here at the Morningstar Investment Conference with Christine Thompson, who is the director of portfolio managers for municipal bonds at Fidelity. Thanks for joining us, Christine.

Christine Thompson: It's a pleasure. Thanks for having me.

Sjoblom: Well, it's been such a wild and wooly ride for municipal bonds over the past year. We had tremendous losses suffered by munis in late 2008. Then fast-forward to this year and all of a sudden there's a huge, tremendous bounce-back for the municipal bond market. I would really appreciate hearing your thoughts on what is impacting all of this volatility, or what's influencing all of this volatility in the market?

<TRANSCRIPT>

Thompson: You're right, Miriam. Without question, municipal bonds have suffered greater volatility than investors had hoped for or ever experienced before. I think there are good reasons as to why you had the technical swings that we've seen. One day there's a demand for municipal bonds that seems endless, and a week later there's very, very few bids. What munis are responding to are the greater financial pressures that exist in the marketplace. I think the lessons for municipal bond investors are to invest for the long term, to use these periods of valuation fluctuations to purchase securities that can perform well over a multi-year time horizon.

At Fidelity, that's what we do. We're researching securities with the expectation that we'll hold these investments over three years, looking to identify those municipal issuers that will offer the long-term security and return advantage that most investors hope for in their municipal bond funds.

We're able to find extraordinary values at times that the market is suffering periods of declining demand.

Sjoblom: It does seem like there is a big disconnect between the movements we've seen in the market and then the long-term fundamental picture for a lot of issuers. I would be interested in hearing more about your view on the fundamentals of the muni market and how as a manager, how do you pick and choose.

Thompson: Right. A lot of the valuation swings that we've seen in 2008 and into 2009 are really driven by the technical situation, money flowing into or out of the asset class, and are reflecting less of the fundamental differentiation that will reward investors over the long term. When investors are particularly risk averse and preferring the liquidity of cash investments, what we're finding is the intermediaries who generally are helping the sellers and the buyers of securities find the equilibrium prices are pulling back. That's causing greater price fluctuations.

We're viewing those periods as a time of great opportunity because armed with the research staff and at Fidelity, we have a team of over 25 investment professionals who are researching bonds. We're looking for securities that based on their fundamentals, are going to be the strong performers over a two- or three-year time horizon.

When the technical swings settle down, I think what investors will find is that the fundamentals are going to matter and are going to determine which are the successful investments.

By doing the work, by identifying those issuers who have the financial strength, flexibility and choices to weather what is going to be a very difficult budgetary cycle, I think portfolios are going to be able to differentiate their ultimate results.

What I would encourage investors in municipal bonds to do is to do the work, do the research. Look at the financial flexibility of issuers. Distinguish between bonds beyond the high-level characteristics.

The municipal market is a very fragmented market. It tends to get treated as though all the bonds in it had all the characteristics of the average.

One of the great things about working with muni bonds is the fact that the asset class does have the ability to have a lot of compelling confidence behind it in these uncertain economic times--but not every security within the marketplace. So differentiating, I think, will be the key to success over the next three year cycle.

Sjoblom: OK, great. I really appreciate your thoughts and thanks for joining us.

Thompson: It's my pleasure.