Recently, MarketWatch featured a story titled “Muni bond funds hit by perfect storm.” There is no better way to describe that during August’s credit crisis all income investments along with tax free muni funds were affected.
The sudden rise in yields caused many large and well known muni bond funds (and CEFs) to drop in price and become another fallout victim of the subprime debacle. Contributing to that down turn was the fact that some Hedge funds engaged in a strategy called muni arbitrage during which the traders try to take advantage of price differences between muni bonds and other type of debt such as Treasuries and corporate bonds.
While that in itself may not have created too much of a problem as prices went against the traders, using leverage was again the culprit that magnified the negative outcome. It’s too early to tell if there is more bad news to hit this sector.
While income investments are designed to be held long-term, there is a point when action needs to be taken if prices slip too much. Why? Because you simply don’t know if a turn around is on the immediate horizon or if prices will continue to deteriorate.
For my clients (and for myself), I liquidated those positions that had performed the worst and kept those that had held up reasonably well. While this puts us in larger cash position than I would like, I feel that prudence is more important than feeling like you’re living on the edge. We may jump back in if those markets calm down.
My point is that market volatility has now also spread to conservative income investments. This means that there is virtually no investment orientation, other than cash, that is immune from sharp price changes caused by unpredictable and uncontrollable factors.
I think Al Thomas was the one who recently said that “sometimes it is better to be out of the market wishing you were in than being in the market wishing you were out.” Truly words of wisdom.