Flee 'Safety', Embrace 'Risk': The Case for Muni Bond Funds

by: Neil George

Think munis are a risky deal? Don't. Instead, buy 'em now.

Back at the beginning of this year, when seemingly every pundit and talking head in the media was telling you to buy safety, I was telling you to buy risk.

Treasuries were in huge demand for many investors trying to secure their retirement income. But Treasuries were exactly what you didn't need.

I understood the motivation behind many investors seeking a safe harbor - that's what Uncle Sam's Treasury represents. You know that one way or another, the US government will pay you. It might be with very depreciated dollars, but you'll get every dollar back - even if they won't buy much.

It's the power of taxation by the guys up on Capitol Hill - along with the printing presses over at Treasury and the ability of the Federal Reserve Bank to inflate and leverage its balance sheet to near infinity - that enables the US government to stand by its pledge of full faith and credit.

States can't print their own cash. And they don't have the ability to run their own central banks. But they can leverage themselves by borrowing against plenty of assets and cashflow receivables. And, like the US government, states do have the power to tax and that's what plenty of them are doing now - and will continue to do more of.

Back at the beginning of the year, many advisors recommended buying safety and dumping risk. This meant that, supposedly, US Treasuries were the smart buy. Corporate bonds and bonds from other nations - especially emerging markets - along with munis were deemed to be too risky and ripe for a further fiasco - just like much of the mortgage and collateralized debt obligation bonds of last year.

But I wasn't going to have anything to do with buying Treasuries. Nope. Yields had plunged, and there was little or no real after-inflation yield to be had.

Buy What?!

To get yield - and not just measly yield, but high yield, the kind that pays you to own and invest - I went where the market pundits were telling you not to go.

I told you to back up the truck on risk.

My starting point was foreign government and corporate bonds - including bonds from emerging markets. My recommended core international closed end bond funds, including the AllianceBernstein Global High Yield (NYSE: AWF), Blackrock Income Opportunity (NYSE: BNA), Pimco Strategic Global Income (NYSE: RCS), Templeton Emerging Markets (NYSE: TEI) and the Western Asset Emerging Markets (NYSE: EFL) have done exactly what I told you they would.

They performed.

Collectively, these five have paid investors to own them by generating a return of over 26 percent so far in 2009. That drowns what the anemic and risk-prone general stock market has produced.

And what has the so-called super safe US Treasury market done for investors so far this year? The benchmark 10 year US government bond has lost investors nearly 9 percent.

Yep - so much for buying safety. Risk pays, if you stress test what you're buying before you buy.

Fiscally Fit

The headlines for munis are pretty scary and that's the way I like them. Everybody is talking and writing about how California is doomed. They talk about the $23 billion-plus deficit for the current fiscal year's budget and how Sacramento is unwilling or unable to fix its budget.

And then there's the late night talk show fodder: the plan to issue IOUs for some state vendors and for tax rebates.

But the reality is that California isn't going to default on its general obligation bonds. And let's also look at the fact that while California is still dealing with its budget woes - only six other states out of the entire 50 haven't completed their budgets.

And for each of those six, there are reasonable plans to raise taxes and impose plenty of fees to settle deficits in the coming days.

Yes, California is the big 800 pound gorilla in the muni market, but it isn't the entire market. And you can be sure market pundits won't be telling the good news, because good news doesn't sell.

But that's what works if you want to find bargains that pay you to own them. And even better, if you want to get them when no one else is buying them - well, at least in public.

Muni Might

Ok, brass tacks time. I'm not going to tell you to start buying individual munis on your own. But I am continuing to tell you to buy three very specific closed-end muni funds that have proven out to pay and perform.

These aren't new: They're the same muni-funds that I've been writing about and talking about at my various speaking engagements this year.

What sets them apart is the underling quality of the munis that they own and manage. And how they keep coming through with checks to their owners throughout the year.

The group includes the AllianceBerstein National Muni Income (NYSE: AFB), The Nuveen Quality Income (NYSE: NQU) and the Blackrock Muni Income Trust II (NYSE: BLE).

Like the so-called risky foreign and corporate bond funds I've been telling you to buy, these have been quietly performing like they should so far this year - all while the usual pundits have been trashing the muni markets as too risky.

The average return for the three is 27 percent for the year. And while you might think that they may have gotten expensive, don't: They trade at a 4 percent discount to the liquidation value of their cash and bonds. And they pay you quite well to own them, with an average Federal tax-free yield of 7.4 percent.

For those of you in the 35 percent tax range, that equates to an after-tax equivalent yield of over 11.3 percent.

The muni market isn't for the uninformed or the novice. Unlike the Treasury market and much of the corporate market - when it comes to munis - you have to know each bond inside and out before you buy, and keep tabs on it after you buy.

Everything - from visible supply, calls, sinking funds, and underlying backing and assets, to who is trading them - comes into play. I know - I've traded them professionally.

This is why I like the closed end funds. But there's one more reason they're especially attractive now:

There are some really great deals on selected munis, and not just in making the right calls on underlying credit. How about munis with US Federal government guarantees? Yep - there are plenty of them out there - but most investors know little to nothing of them.

Each of my recommended funds owns a chunk of these, as well as plenty of regular munis from around the nation, including a number of states with no fiscal pressures.

Buy them, collect the checks and watch US Treasuries further weaken - while your munis and your global bonds make risk pay you.

Disclosure: Long Positions: AllianceBernstein Global High Yield (NYSE: AWF), Blackrock Income Opportunity (NYSE: BNA), Pimco Strategic Global Income (NYSE: RCS), Templeton Emerging Markets (NYSE: TEI) and the Western Asset Emerging Markets (NYSE: EFL), AllianceBerstein National Muni Income (NYSE: AFB).

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