Barron’s posted an article about California IOUs along with some thoughts on the possibility of purchasing muni bond funds. Let’s listen in to “California Scheming:”
The outcome of the California crisis ultimately will be determined by politics. As I pointed in the print edition of Up & Down Wall Street a few weeks ago, “Having bailed out the banks and provided a lifeline to Chrysler and General Motors, how does Washington tell California, the eighth-largest economy in the world, to drop dead? That’s the slippery slope that America’s credit rating is on.”
That said, Timothy McGregor, Northern Trust’s director of municipal fixed-income management, writes of California, “We believe that there are ample safe and attractive tax-exempt investment opportunities with the state that allow for diversification. We are finding potential value in unlimited tax general obligations bonds.”
Long-term California state GOs are yielding about 5.80%, equivalent to almost 9% for an investor in a 35% tax bracket and higher still for a Golden State resident paying that state’s taxes.
McGregor adds: “We believe the pronounced weakening of municipal balance sheets during the last two years makes the potential benefits of achieving at a least a portion of many investors’ tax-exempt exposure through mutual funds especially compelling. Mutual funds offer a level of diversification, liquidity and transactional efficiency that even large institutional investors have trouble achieving on their own.”
For instance, the no-load Vanguard California Long-Term Tax-Exempt Fund (VCITX) offers those attributes with a yield of 4.39% and an expense ratio of 0.19%. For the more adventurous, there are California closed-end muni funds.
According to etfconnect.com, California closed-end funds sell at discounts to net-asset value of as much as 17%, which is exceeded only by a handful of Michigan closed-end funds. (Closed-end funds trade at a discount or premium to their NAVs on stock exchanges depending on their demand and supply in the market.) And as parlous as the conditions in California, they’re not as bad as Michigan’s.
Yields of as much as 7% are available from a variety of California closed-end muni funds trading at discounts of about 15%. On a taxable-equivalent basis, that’s equal to the double-digit yields on corporate junk bonds. But the high yields are the result of leverage in the funds, which boosts their risks.
All in all, California closed-end muni funds offer the potential for equity-like returns, albeit with undeniable risks, but arguably less than stocks’. And they could get still cheaper if the state’s fiscal crisis worsens and nervous holders dump anything with California in the name. That would be the time to pounce.
The last sentence says it all. Munis could get cheaper, and you really are put in a position to try to pick a bottom if you consider these investments.
My personal view is far less enthusiastic. I don’t think much of bottom picking to begin with. However, more importantly, we are entering unchartered territory when it comes to State and municipal deficits along with severe budget problems. Potential bankruptcies are certain to become a viable option.
What good does a high yield do, if you lose far more on the principal side, which is exactly what happened last year?
In terms of deficits, things have gotten far worse since then, and no one knows if a bottom is even on the horizon. I don’t like to bet on totally unknowns in the hope that I might get lucky. I will stand aside on this one.
Comments 5
Re your question, "What good does a high yield do, if you lose…on the principal…?", are you referring to NAV? Share price? If a long-term investor is only seeking tax-free income, and his yield is, e.g., 7% at the time of purchase, how much concern should he have for share price variations?
I have chosen to ignore the effect of individual bond issue defaults, as I have assumed a large, well managed diversified mutual fund portfolio.
Too much risk for me in the Muni department. The only way I'd consider it would be to buy a well diversified fund. Once again, wise advice for your readers Ulli.
Anon,
I don’t like to invest for a good dividend yield and then surrender a larger part of my principal to market fluctuations. For example, if I had invested $1 million in muni funds at the beginning of 2008 with a nice yield of 7% that would have given me $70k in income. Say I spent that money, I also would have seen my principal balance (NAV) deteriorate by some 30% leaving me with some $700k at the end of 2009. I don’t know about you, but that does not make sense at all, and I would not have been a happy camper.
Ulli…
Well I guess some look at it that they spend the income/yield and when they die someone else gets a hunk less. Why not just spend the 300K principal and have some fun. Why let it evaporate…
Huh!!! I remember Bob Brinker talking for years touting Calif munis and snickering do you think the great state of Calif, the world's 8th largest economy, will go bankrupt…
Its easy just legalize and tax grass. The payback just in the lesser amount of tirals and incarceration is several billions. If Nevada had gambling and pros legal well I'd buy lots of munis if we had forward thinkers…
Of course we could alwayd revoke prop 13 or amend it. Those covered by prop 13 with kids in school pay the higher tax rates yearly. Those without school age kids, pay the tax at time of sale or during estate settlement. Why should folks gain value in their property due to population density whle paying none of the assoicated costs of that density. Another republican trick