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Q

In your commentary, “Interest Rate Reality,” you repeat the mantra, “look first for appropriate quality, then focus on yield.” You also advocate buying long-term individual muni bonds and holding them to maturity— great advice, if the bonds are not callable. The reality is that most, if not all, of the available bonds are callable, some within a year or two. Do you have any general guidelines on how to gauge whether a callable bond is or is not likely to be called?

A

James A. Klotz responds:

Having read our commentary and analysis for several years, we’re sure you know that we believe trying to predict the future direction of interest rates can be a fruitless venture.

Unfortunately, this would be the only way to forecast the potential for bonds being called.

Simply put, an issuer will be incentivized to call outstanding bonds when prevailing interest rates enable the issuer to borrow at a lower rate than it is paying on existing debt.

We believe, however, call features and “worst case yields” can be very valuable tools when contemplating a muni bond purchase.

We like to select bonds trading above 100 that have worst case yields higher than a par bond would yield in that year, and the premium bond will invariably produce a higher yield to maturity if the bonds are not called.

This approach gives the investor the best of both worlds.