Municipal Bond Forum

Home > Municipal Bond Forum > An opportunity during muni redemptions

An opportunity during muni redemptions

Q

I have a laddered portfolio of California municipal bonds, many of which were purchased in 2007 at or around par. Most have coupon rates of 5.00% and are being redeemed this month. In order to reinvest in similar munis, I had to pay a 16% to 20% premium. In your article, “Summer Forecast: A Muni Redemption Flood, Supply Drought,” you said investors can often enhance their tax-free income when bonds are redeemed. With regard to these 2007 bonds, I don’t see how redemptions aren’t an issue or how reinvesting in similar bonds can enhance my tax-free income. In the decreasing-rate environment that has been in place for around 30 years, shouldn’t investors hope that older bonds are not redeemed?

L.C., California

A

James A. Klotz responds:

You may know from visiting our website that we have never been proponents of laddering municipal bond portfolios.

This strategy, however, continues to be recommended by stock brokers and financial planners, which, sadly, has short-changed too many muni investors (see, for example: “Bond Laddering: “An Idea Whose Time Still Hasn’t Come“).

If you built a 10-year ladder in 2007, you may have purchased bonds with 5.00% coupons, but you would have paid prices in excess of 100.00 (par). If you are taking your costs from brokerage statements, they likely reflect your adjusted costs after amortization and, naturally, would be, as you say, “at or around par.”

If your ladder had bonds maturing every two years, unfortunately you have been forced to reinvest your funds at lower yields in each instance.

Our clients buy longer-term bonds to maximize their tax-free income. For the most part, they are buy-and-hold investors, as you seem to be. By extending your maturities, you can “enhance” your tax-free income substantially.

The “Municipal Market Monitor,” provided by Thomson Reuters, reflects that a 10-year, AA-rated bond yields approximately 2.01% in today’s market. A similarly rated 30-year muni will yield 2.89%.

On a $100,000 investment, the 30-year bond will produce $880.00 more tax-free income annually, which is actually 30% more than the 10-year security. This can be extremely significant when applied throughout your portfolio.

Ladders are usually recommended by brokers who are inordinately focused on maintaining level market values.

Our investors understand that the market value of a long-term bond will sometimes be less than you paid and sometimes more. Neither situation in itself should trigger a sale.

Yes, as you suggest, redemptions are an issue, particularly in a market that is sensitive to supply-and-demand factors.

Jun 12, 2017

Start here.

Do you have specific criteria for bonds you’re looking for? Let us know and we’ll e-mail you bonds that fit your needs. There is no charge for this service.

    This report is produced solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. This report is based on information obtained from sources believed to be reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed.