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Q

I read your recent article about the significant rise in muni prices (“Muni Market Returns Rise Amid ‘Gluttonous’ Demand”). My muni portfolio has done very well. But even though prices have gone up, reinvesting redemptions at 1.5% yield-to-worst isn’t very attractive. Since you frequently state that the main purpose of municipal bonds is to generate a stream of tax-free income, it doesn’t seem too lucrative. In hindsight, your advice to invest in long duration municipal bonds was a great strategy. What are your thoughts for new investors or someone whose portfolio is having a lot of calls and maturities?

A

James A. Klotz responds:

Although we certainly understand your dilemma, no investment can be analyzed in a vacuum.

Alternative investments must be considered.

As you know, California has one of the highest state-tax levies in the country, which means your muni yield must be considered in the context of taxable equivalents.

Accordingly, when it comes to fixed-income investments, the taxable equivalent yield on your municipal bonds far exceeds the after-tax yield of Treasury and corporate bonds.

Parking funds in a money market waiting for rates to rise has proven to be a very costly strategy, and equities may require more risk than you are comfortable with.

Municipal bond funds have attracted unprecedented dollars in the last two years, proving there is still a large investor appetite for tax-free income.

Many of these funds quote higher yields than individual bonds through the use of leverage, but once again, require somewhat higher risk tolerance.

Although we do not predict future interest rate levels, there is no question that in this global environment of negative interest rates, muni returns could decline further.