Medalist Muni Funds for Your Consideration
Investors seeking tax-free bond income have several good options.
Our Picks
Note: This article is part of Morningstar's February 2014 Tax Relief Week special report.
With many bond funds yielding less than their historical averages these days, the last thing most fixed-income investors want is a tax bill eating away at that income. And for investors in higher tax brackets, the thought of losing one third or more to taxes from a fund that yields just 2% or 3% to begin with sounds pretty unattractive. Enter municipal-bond funds.
Because municipal bonds distribute tax-free income, they hold a special appeal for high-tax bracket investors. The downside is that muni bonds typically pay lower yields than comparable taxable bonds, but this shortfall may be overcome by the tax savings they offer.
Determining whether municipal bonds are right for you requires weighing various factors, as outlined in this article. One way to do this is by calculating the bond's tax-equivalent yield, a method of comparing the aftertax yields of muni and taxable bonds on an apples-to-apples basis. You can do this with a tool such as Morningstar's Bond Calculator, which requires information about whether the municipal bond is exempt from state and local taxes and what your federal and state tax rates are.
For investors who have decided that municipal bonds are right for them, we've used our Premium Fund Screener to find some of the best municipal funds in the national intermediate and national short categories that are currently available to individual investors. (We'll leave long-term muni-bond funds for another time given that many investors are concerned about rising interest rates, and such funds are likely to be more vulnerable.) All have Morningstar Analyst Ratings of Gold, Silver, or Bronze, meaning our analysts have vetting these funds for attributes such as price, performance, quality management, and parent company. We've excluded load funds from our list, but those who don't mind paying a load or who have access to no-load versions of some funds can delete that element from the screen. For the full list, click here (Premium Membership required). Below are a few funds that passed the screen.
Fidelity Limited Term Municipal Income (FSTFX)
Manager Mark Sommer focuses on identifying pockets of relative value along the yield curve, within specific bond structures, and among different credits, with a bias toward quality names, writes Morningstar senior fund analyst Sarah Bush. The Gold-rated fund's duration (a measure of interest rate sensitivity) of 2.8 years (as of Dec. 31) is a bit long for a short-term muni fund, meaning its holdings may lose more in value than those of its average peer if interest rates continue to rise. The fund is led by a strong management team that operates within one of the industry's best fixed-income shops. The fund's 10-year annualized return of 2.8% (as of Feb. 25) is 54 basis points better than the category average. Expenses (0.47%) are below-average for a municipal-short, no-load fund.
Wells Fargo Advantage Short-Term Municipal Bond
Comanagers Lyle Fitterer and Wendy Casetta draw from a broad tool kit that combines duration and yield-curve positioning driven by the firm's macroeconomic outlook with a heavy emphasis on sector allocation and individual security selection, says Bush. With an eye on interest-rate sensitivity, this fund's management team has kept duration short at 1.26 years (as of Dec. 31). On the other hand, it has been willing to take on extra credit risk to boost returns, focusing on issues it believes are mispriced. Nearly one fifth of the portfolio consists of issues rated BBB or below or that are unrated, nearly 3 times the weighting of the category average. The Bronze-rated fund's 10-year annualized return of 3.1% is 85 basis points better than the category average. Expenses (0.63%) are above-average for a municipal-short, no-load fund and may rise if a fee waiver expires as scheduled on Oct. 31, 2014. A load version of the fund, with lower expenses, is also available.
Vanguard Intermediate-Term Tax-Exempt (VWITX)
Despite a management change in June 2013, this fund remains a strong muni fund pick. It holds a broadly diversified, high-quality portfolio that is largely unexceptional. Where the fund does offer a key advantage, however, is in its price (0.20%), which makes it one of the cheapest intermediate-term muni fund offerings available. The Silver-rate fund's duration (5.5 years as of Dec. 31) is about average for the category. During the past decade annualized returns (3.9%) have beaten the category average by about half a point.
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