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Opportunities in high yield municipal bonds

- Alan Lavine and Gail Liberman

The taxable equivalent yields of high yield municipal bonds were on par with taxable high yield corporate bonds as we wrote this column.

This sounds pretty attractive! High yield municipal bonds typically are issued to finance economic or industrial development, housing, environmental projects and health and retirement care facilities.

They were paying 5.5 percent or more tax-free. That translates into taxable equivalent yields of 7.5 percent for high tax bracket investors.

John Cummings, manager of the PIMCO High Yield Municipal Bond Fund, expects steady returns on high yield tax-free bonds. Default rates have averaged less than 2 percent over the past 30 years, and the recovery rates are high.

"The demand is strong and issuer default rates are low," Cummings said. "Where there are defaults, the recovery rates are high. You can pick up (1 percentage point) and not increase your default risk by investing in high yielding municipal bonds."

Cummings owns 65 different bonds and no one issuer makes up more than 1 percent of his portfolio. In selecting bonds, he looks for issuers that are economically viable. The issuers must have strong cash flow and debt coverage ratios compared with their peers. The issuers should have a strong franchise for their services.

Many bond issues are tied to revenues, such as the Newport Beach, California toll road or local hospitals.

The greatest risk to high yield muni bonds, Cummings says, would be a change in the federal income tax rate. Lower tax rates make tax-free bonds less attractive. Natural disasters, like hurricanes, earthquakes and tornadoes could send bond prices tumbling.

Beware that as we wrote this, a 1 percent rise in interest rates would have resulted in about an 8 percent decline in the price of the bonds held by Cummings' fund.


Spouses Gail Liberman and Alan Lavine are syndicated columnists. You can purchase Alan Lavine & Gail Liberman's latest book Quick Steps to Financial Stability (QUE Publishing 2006) online at www.moneycouple.com or at your local bookstore. E-mail them at MWliblav@aol.com.

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