Fundline: Tax-free bonds out-yield taxable bonds
— -- In the normal course of events, tax-free municipal bonds usually yield less than taxable bonds. But the financial world is turned upside down, and non-taxable bonds now offer tastier yields.
All bonds are interest-paying IOUs, and the amount of interest they pay depends, in large part, on their creditworthiness. An issuer teetering on the edge of bankruptcy will pay far more interest than the U.S. Treasury, which can raise taxes or even print money in a pinch.
Cities, states, towns and other municipal entities issue bonds to pay for schools, roads and other projects. The interest these bonds pay is exempt from federal tax — and state tax, too, for bondholders who live in the issuing state.
Because munis have a big tax advantage, they almost always yield less than taxable bonds, such as Treasury securities. Someone in the 33% tax bracket, for example, would have to earn 3.8% in a taxable bond to get the same after-tax return as a 2.6% tax-free bond. (If you want to calculate a muni bond's taxable-equivalent yield, www.investinginbonds.com has a calculator.)
But the global financial crisis has sent investors scrambling into ultrasafe Treasury securities, pushing yields down. A 10-year T-note, for example, yielded just 2.90% Friday. A 10-year, highly rated municipal bond yielded 3.44%.
Why? Big investors haven't scrambled to munis, in part because most institutional investors don't give a hoot about taxes. Munis aren't backed by the full faith and credit of the U.S. Treasury, meaning there's a chance a muni bond could default.
But states and towns can raise taxes to meet debts, and muni bond defaults are extremely rare. If you're looking for high yields and low taxes, munis look like one of the best deals out there.
More change for money market funds
Ever since the Reserve Fund imploded in September, both government and industry have been wondering what, if anything, to do about ensuring the safety and soundness of money market funds. Millions of investors use them as a safe haven for their temporarily idle cash. And the $3 trillion money fund industry plays a vital role in keeping the short-term money market operating properly.
Shortly after Reserve went down in flames, Treasury guaranteed money fund assets as of the close of business on Sept. 19, 2008. The guarantee was set to expire April 30, but Treasury has extended it to Sept. 18, 2009. Funds will have to pay a fee to get the insurance. But insurance is just a quick fix. The Group of 20, an economic consulting firm of high-level former government and private bigwigs, recommended that money market funds be insured by the Federal Deposit Insurance Corp. In return, they would be regulated by the FDIC and, in essence, stop being money market funds. Those that wanted to continue as money funds would have to give up their constant $1 share price. The fund industry, not surprisingly, didn't like the Group of 20's proposal. So the Investment Co. Institute, the funds' trade group, came forward with its own recommendations:
•Funds keep at least 5% of their assets in investments that can be liquidated overnight.
•Funds keep at least 20% of their assets in investments that can be liquidated in seven days.
•Funds keep the average maturity of their investments at 75 days, down from 90 days now.
Barry Benjamin, U.S. leader of PricewaterhouseCoopers' Investment Management practice, thinks the ICI's plan has the greater chance of being adopted by federal regulators. For one thing, the SEC has more experience with money market funds than Treasury — or the FDIC — does. Banking regulators have their hands full now, anyway. And, he says, money funds have fared reasonably well since their inception nearly 50 years ago. "They've had two failures," Benjamin says. "That's a better record than the banking industry."
Fund news ...
Robert Rodriguez, manager of FPA Capital and FPA New Income, is one of the few fund managers who has a good record with both stocks and bonds. But he's taking a year-long sabbatical and, upon return, won't be as much of a hands-on manager for either fund.