For investors looking for a safe, fixed yield from municipal bonds, the WSJ’s Jason Zweig has a warning: watch out for mutual fund managers who are making risky bets.
In the article Muni-Bond Bargains: Devil’s in the Details, Zweig highlights the case of the Eaton Vance National Municipals Fund which was down 31.6% in 2008. Turns out that the Eaton Vance managers were putting investor funds into highly volatile tender-option bonds.
Tender-option bonds are a derivative product that strips the short term, fixed yield out of a municipal bond and keeps the long term, variable portion. When interest rates or other factors change, the value and yield of the derivative can change wildly. As an example, one of Eaton’s investments declined in value from $5.4 million to $2.6 million in just 6 months.
Zweig figured this out only after careful inspection of footnotes in a semi-annual report. One of the major drawbacks of mutual funds is the secretive nature of their holdings which are only revealed weeks or even months after the fact.
By contrast, exchange traded funds are completely transparent with portfolio holdings updated daily. Investors have a wide selection of municipal bond ETFs to choose from. Zweig recommends the iShares S&P National Municipal Bond Fund (MUB) as a solid choice.