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Feeling the Heat From Puerto Rico

The commonwealth's fiscal and bond-market woes have dealt pain on mutual funds.

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Puerto Rico has struggled with financial problems for a while. Things began deteriorating even before the 2008 financial crisis, thanks in part to a 2006 tax-benefit expiration and the resultant exodus of manufacturers from the island, according to Morningstar municipal credit analyst Candice Lee. The commonwealth's difficulties have only worsened since then, with well-documented strains such as a crumbling infrastructure, high crime, and unemployment all coming up against a contracting economy and weak tax revenue. 

In the Penalty Box
Although Puerto Rico's bonds bounced back strongly after the financial crisis according to Barclays data, investors began to penalize them more severely in 2012, when, as a group, their returns were less than half that of national muni benchmarks. After the broader bond market began to sell off in May 2013, however, Puerto Rico's fortunes began to slip from bad to worse. Detroit's bankruptcy filing naturally spooked investors, who began looking around to see which might be the next shoe to drop. Negative headlines and new data about the commonwealth's fiscal challenges didn't help matters. Its bond yields had already blown out to an average of 6.8% by the end of September 2013--some individual issues fared much worse--when Standard & Poor's lowered its outlook on bonds issued by the island's Sales Tax Financing Corp. (COFINA). The U.S. government shutdown that began on Oct. 1 only added insult to injury given that Puerto Rico relies on federal funding for an unusually large percentage of its own government spending. From the start of May through Oct. 1, 2013, Barclays' Puerto Rico Index tumbled 18.7%. That compares with a 4.4% loss for the broader Barclays Municipal Bond Index.

Eric Jacobson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.