Muni Bonds Will Outperform - Barron's Interview

Barron's interviews Legg Mason (LM) bond portfolio managers Joe Deane and David Fare, and picks their brains on recent turmoil in the muni-bond markets and how it's played out.

The recent liquidity dry-up led to major bond players, including a host of hedge funds, de-levering their holdings. The result was unprecedented volatility that created exceptional buying opportunities, as many funds were hit with margin calls that forced them to liquidate positions at fire-sale prices. Further complicating the issue was a crisis at monoline insurers, which guarantee municipal bonds.

Legg Mason Partners Managed Municipals Fund took advantage, using its liquidity to snatch up mainly high-grade paper (AA and A). High-yielding issues were also game, if the spreads made the risk worthwhile. The duo favors pre-refunded bonds, which enables them to buy shorter-term bonds (6-8 years) with interest payments identical to longer-term debt (30-year), and "bullet-proof" credit quality.

Much of the muni-bond bargain-hunting is already done with, they concede, but they note that Treasurys are fully-priced, and think munis will gradually outperform. "Munis are so fundamentally cheap compared to the Treasury market right now. So if rates do back up, the price of munis will go down less than the price of Treasuries will," Deane says.

U.S. airline bonds and tobacco bonds are a pass, they say. The former due to the risk of high fuel prices, and the latter because its debt is tied to master settlement agreements, which stem from lawsuits against the companies and limit the revenue to diminishing domestic tobacco sales. Plus, there's always the risk of further lawsuits.

===================================

Tom Lydon takes a look at a smattering of muni-bond ETFs, including PZA, ITM, MUB, TFI, PVI and SHM. Van Eck ETF associate Glenn Smith says muni's current out-yielding of Treasurys is something that happens "once every 7-10 years or so," and calls muni-bond ETFs a "win-win situation."

Bespoke sees a decided uptrend forming in the following chart:

Comments

[R. Richard ...:]

You do a great job in summarizing the wheat in many chaff-laden pieces from Barrons, plus the occassional worthwhile side comment

2008 May 04 12:28 PM

[SA Editor E...:]

Thanks Richard, glad you enjoy!

2008 May 04 12:55 PM

[Egg:]

What's the point of buying Munis over Treasury bonds if you're getting less than the rate of inflation in both?

You are losing real dollars in both year over year, plus paying taxes on your "gains."

2008 May 04 04:25 PM

[Dave M.:]

Their analysis of tobacco bonds is suspect. "Impending lawsuits"? That makes no sense. The MSA has nothing to do with future lawsuits. In faxt, the MSA protects existing tobacco companies from any possible future competition. Are you reading the article wrong or is their analysis wrong?

2008 May 05 11:05 AM

[EE:]

With M3 growing at over 15% the last 5 years and inflation starting to catch up and then make up for lost time. how can any paper promise including the $ make sense for anyone thinking longer than 90 day trades? The dollar will lose another 50% in less than 5 years. Read Butler and Hommel. investmentrarities.com & silverstockreport.com Butlers April comments and Jan 15...Hommels Feb 6th. There is where wisdom rests. Sell all bonds,notes, and get hard stuff people and industry use.

2008 May 05 11:13 AM

[SA Editor E...:]

From Dave M.: ""Impending lawsuits"? That makes no sense. The MSA has nothing to do with future lawsuits. In faxt, the MSA protects existing tobacco companies from any possible future competition. Are you reading the article wrong or is their analysis wrong?"

Thanks for your comment. In a quest for brevity, I misstated the issue. To quote Barron's: "Tax-exempt tobacco bonds are tied to master settlement agreements, which stem from lawsuits against the tobacco companies. And when you have a bond that is backed by an MSA, you basically are only getting the revenue from the domestic tobacco sales, which are diminishing. And you never know about another lawsuit against one of the tobacco companies."

I have corrected the article to reflect this. Thanks for bringing it to my attention!

2008 May 05 11:43 AM

[Jake2:]

Article plus comments on the article enough to make anyone gun-shy of the whole mess.

2008 May 05 12:38 PM

[Bingo 2:]

Muni bonds scare me totally. The basis of their return is local taxation and with the problem in housing, I can not see Muni's as being very secure. Please tell me otherwise so i can jump back into Muni bonds.

2008 May 05 01:29 PM

[User 30121:]

WHEN DONKEY'S FLY! WHAT THE HELL, BUY THEM, THAT WAY THERE WILL BE MORE SILVER AND GOLD FOR ME!

2008 May 05 03:30 PM