EnvisionCap.com: Forbes Article - Why Munis Are a Compelling Buy -- Now

Why Munis Are a Compelling Buy -- Now

Marilyn Cohen, Forbes Magazine, 10.20.97

DURING THE 1980S a few economic sages predicted that shrinking Treasury auctions would cause a scarcity of Treasury paper. Most of us thought they forgot their daily dose of antidepressant. As it turned out, these sages were right and the rest of us were wrong.

I now believe that the next scarcity will be in municipal bonds and that the dearth will last a decade or more. That means higher prices and lower yields. It means that you should buy your munis now.

The chart shows the outstanding supply of tax-exempts in constant dollars. (It includes nongovernment bonds that qualify for tax-exempt treatment, such as pollution-control bonds issued by a utility.) Already the supply is tapering off. This at a time when the demand is likely to rise from baby boomers retiring and needing low-risk securities for income.

Munis will no longer be for our coupon-clipping parents. We will have become our coupon-clipping parents.

The current supply is artificially swollen by refundings. Suppose a town floated a $5 million issue a few years ago to finance a school auditorium. Since interest rates have dropped, the town would like to refinance. But the bond issue isn't yet callable. So the town floats a second issue and sets aside the proceeds in an escrow account to pay off the first issue as soon it can be retired. Now there is $10 million of municipal debt outstanding;but not for long.

Muller Data, a division of Thompson Financial specializing in municipal bond data, says half of the total outstanding munis will mature within the next ten years;$645 billion worth.

Nail down those yields before its to late.

Sources: Federal reserve System; Bureau of labor Statistics *Twenty-year Bond Buyer Index verses 30-year Treasury. Source: John Nuveen & Co.

I see no great new supply coming to market to replace the maturing stuff. Voters are more reluctant than they used to be to approve boondoggles. Privatization of everything from hospitals to prisons will divert future debt financing away from the muni market into the taxable market. Water, power, solid-waste and resource-recovery projects are slowly working their way into the private sector.

Demand, however, is certain to grow. We have all heard the financial planning wizards preach that the percentage of bonds in your portfolio should match your age. We will hear that sermon with increasing frequency in the future. Munis will no longer be for our coupon-clipping parents. We will have become our coupon-clipping parents.
Over the past 15 years, muni yields have ranged from 77% to 86% of Treasury yields. For the next 15 years, I think 77% could be the high-water mark. If you are in the 28% tax bracket, a muni yielding 77% as much as a Treasury is attractive. If, like a lot of Forbes readers, you are in the top federal brackets;effectively, in excess of 40%;munis are even more attractive.

The tide hasn't turned yet, but successful investing is about anticipating future trends. If you need li-quidity, buy a no-load muni bond fund with a low expense ratio. If you don't, buy high-quality bonds directly and hold to maturity. Be attentive to call risk. If I am right that interest rates on municipal bonds are going to come down, there will be a lot of calls. Protect yourself by focusing on bonds that have low coupons and are trading at or below par. These will be the last to be called in if there's a decline in interest rates.

Marilyn Cohen is president of Envision Capital Management®, Inc., a Los Angeles fixed income money manager. Visit her home page at www.forbes.com/cohen.