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Why are muni-bond mutual funds tanking?
Old 12-15-2010, 06:49 PM   #1
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Why are muni-bond mutual funds tanking?

I bought into four of these funds in January of 2010. Each month this year the NAV went up and the dividends were paying out well. I was very satisfied with them. Then right after QE2 announcement, I noticed that they became very volatile. They would swing much more downward and bounce back only a portion of their loss. Then they just started tanking and are still going down. They lost all of their NAV gain for the entire year in one month and took back all of the dividends too. I am just amazed at the performance of these funds. Luckily I was watching them closely and sold before I lost my shirt but since then they are in a steady downfall.
I don't understand why this is happening and was wondering if anyone here could explain the performance?
The funds are ftabx, fstfx, fltmx, fhigx.
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Old 12-15-2010, 06:51 PM   #2
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Originally Posted by dessert View Post
I bought into four of these funds in January of 2010. Each month this year the NAV went up and the dividends were paying out well. I was very satisfied with them. Then right after QE2 announcement, I noticed that they became very volatile. They would swing much more downward and bounce back only a portion of their loss. Then they just started tanking and are still going down. They lost all of their NAV gain for the entire year in one month and took back all of the dividends too. I am just amazed at the performance of these funds. Luckily I was watching them closely and sold before I lost my shirt but since then they are in a steady downfall.
I don't understand why this is happening and was wondering if anyone here could explain the performance?
The funds are ftabx, fstfx, fltmx, fhigx.
I think you did.
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Old 12-15-2010, 06:53 PM   #3
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I think you did.
Thanks Ha. Is that happening to all bond funds right now?
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Old 12-15-2010, 06:55 PM   #4
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Aside from the general rise in yields (10 year treasury yields are up more than 1% from the lows), there is a weird technical issue in the muni market. A lot of muni borrowers had been issuing Build America Bonds, taxable bonds issued by municipal issuers with a tax equivalent subsidy from the feddle gubmint. It appears that the feds are shutting off the spigot for BABs, so all that volume of supply/new issuance is coming back into the tax free muni market. It is large enough in a short enough window that it has put pressure on prices and yields have been rising. We are starting to get to the point that I get interested in munis, albeit shorter maturities.
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Old 12-15-2010, 07:13 PM   #5
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I have been waiting for months to add money to my muni bond funds and it sounds like the opportunity is nearing. I think that Brewer's explanation is right on.
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Old 12-15-2010, 07:19 PM   #6
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It appears that the feds are shutting off the spigot for BABs, so all that volume of supply/new issuance is coming back into the tax free muni market. It is large enough in a short enough window that it has put pressure on prices and yields have been rising.
Thanks for the info Brewer. Could you explain that part of your statement further?
I don't understand that fully.
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Old 12-15-2010, 07:37 PM   #7
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Thanks for the info Brewer. Could you explain that part of your statement further?
I don't understand that fully.

Unless Congress changes its stance, new issuance of BABs is done. Municipalities still need to issue a lot of bond and the BAB market had lowered yields by bringing in borrowers happy to buy taxable bonds. Those buyers are shut out now and the supply of traditional tax free munis is overwhelming the demand from buyers of same.
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Old 12-15-2010, 07:42 PM   #8
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Unless Congress changes its stance, new issuance of BABs is done. Municipalities still need to issue a lot of bond and the BAB market had lowered yields by bringing in borrowers happy to buy taxable bonds. Those buyers are shut out now and the supply of traditional tax free munis is overwhelming the demand from buyers of same.
Ok, so it's just a matter of supply and demand that is running the NAV of the funds down? And that is why you say it's time to consider getting in?
I'm totally out of them now but thought I would buy back in later but at a lower percentage of investment. I understand the shorter maturities.
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Old 12-15-2010, 08:08 PM   #9
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Supply/Demand plus changing interest rates will change the price

NAV will move opposite interest rates
so when QE2 happened, rates were supposed to go down, but they went up instead. Rates up, NAV of muni funds go down...

add to that the uncertainty of the governments (local govt's) which issue munis, if they are short revenue, it is possible those bonds go to default...

therefore the value of the bond goes down because the coupon of the bond is fixed (coupon is the interest rate the bond was issued at). So if I have a $1000 muni bond paying a 4% coupon (pays $40 per year), and the issuer (a municipality or local government) shows signs of weakening, that $1000 bond might now be valued at $800. It still pays $40, but people will not pay $1000 to get $40, but they might pay $800 to get same $40 in yearly interest.

Supply/Demand
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Old 12-15-2010, 08:31 PM   #10
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All bond are taking a hit.
BigCharts - QuickCharts

As others have mentioned, the Fed actions and there has been more talk about trouble in Spain lately.
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Old 12-15-2010, 10:06 PM   #11
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This weeks letter by John Maudlin's titled "unintended consequences" has some though provoking observations.

Quote:
Correct me if I'm wrong, but I seem to remember that one of the reasons for QE2 was to lower rates on the longer end of the US yield curve. Clearly, that has not happened? Today we look at come of the unintended consequences of monetary policy, turn our eyes briefly to consumer debt, and wonder about deflating incomes...

Look at the chart below. The yield on ten-year US bonds has been rising since the beginning of QE2. But it is not just US bonds; European and UK bonds are moving up as well. This has also meant that mortgage rates in the US are up almost a half percent in the last few months. That certainly has not helped housing prices or sales, as it makes housing less affordable. (Chart from my friends at Variant Perception.)

But it is not just the US and UK. Look at what is happening to German bonds, supposedly the safest in Europe. They are up about as much as their counterparts. (Chart from Cowen International and data from Bloomberg.)

And then we look at Japan and we see the same phenomenon. Japanese real rates going up? Really? What is up with that?

In Europe it is now cheaper to hedge against corporate default than sovereign default. That is not the way it is supposed to be.

My friend and fishing buddy David Kotok of Cumberland Advisors is in London at a conference where they are discussing this very issue. He sent a note that says:
"In meetings today we speculated that the sell-off is not a US-only phenomenon. We speculated that it is more than a reaction to Bernanke's QE2. If all benchmark 10-year debt is selling off by about the same amount in price change, could it be that this selling is the reallocation of globally indexed funds away from sovereign debt and into something else?
"Think of yourself as a Persian Gulf fund. You usually hold foreign sovereign debt in proportion to an index or benchmark. Now you want to reduce your exposure to some of the countries in the index. You either have to sell proportionately from all of the countries in the index or you will face a concentration that violates your index or benchmark. Worldwide sell-off in benchmark sovereign debt suggests this reallocation is underway. Otherwise, how can you account for the Japanese government bond, the German Bund, and the US Treasury note all moving in a correlated way?"
I think that is part of it. I also think that investors and non-core central banks (those in the emerging world especially) are asking themselves about the wisdom of holding sovereign debt in currencies that are either in trouble (the euro) or have central banks that are printing money (the US, UK, and Japan). Couple that with the US having just done a tax compromise that is one huge stimulus bill, on top of extending the tax cuts, and it is enough to make investors consider the wisdom of holding longer-term debt at low rates.

Earlier this year I did one of my Conversations with John Mauldin with professors Carmen Reinhart and Ken Rogoff, who wrote the book This Time is Different. Here is a quote from Ken:
"I would say that virtually every country in the world is grappling right now with how fast we get out of our fiscal stimulus and how much do we worry about this longer term problem of debt. And I fear that all together too many countries will wait too long, which doesn't mean you end up getting forced to default, it just means the choices get more painful. Something we just find as a recurrent theme, is you're just rolling along, borrowing money and it seems okay, and that's what a lot of people say and wham, you hit some limit. No one knows where it is, what it is, but we know you hit it. Carmen and I do have numbers of what are really high debts and what aren't. And the U.S. will hit that [limit] and there are people who say it is not a problem and everyone loves us, greatest country in the world, where else will the Chinese invest? And you want to hear a great, "this time it's different" theme that's a new one.
There aren't a lot of great investment opportunities out there. Historically government (both at the Federal and local level) has been considered pretty safe on the theory that heck they can always raise taxes. But what if they can't?

We have seen a wide variety of response by governments in trouble with excessive debt. The lets kick the can down the road e.g. California, Uncle Sam. Damn the IMF has gun to our head l guess we have to do something, Ireland, Greece. We better do something now while we still can, Britain, New Jersey, France (sort of). By and large the cuts and higher taxes, have been met quite literally with rioting in the streets.

So if you are government official and your government has borrowed too much money you have two bad choices. Option 1 telling the bond holders to go pound sand, even if that means nobody is going to lend you a dollar for a generation. Option 2 tell the rioting citizen, sorry it sucks but benefits are cut, and taxes are raised. I think as more and more people realize that option 1, although unthinkable a few years ago, is actually an a viable option we are going to see investor demand a risk premium for loaning money to governments.
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Old 12-15-2010, 10:43 PM   #12
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so if a municipal bond is defaulted, does the bond holder get to sue in bankruptcy court for city assets? (land, buildings, etc.)?
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Old 12-15-2010, 11:09 PM   #13
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so if a municipal bond is defaulted, does the bond holder get to sue in bankruptcy court for city assets? (land, buildings, etc.)?
I think the short answer is we don't know but it seems unlikely. There is a long paper about the Orange County bankruptcy, basically it appears that bondholders, eventually got paid but they lost interest and and had to wait a few years to get there money.

The news articles about the Vallejo bankruptcy are basically requiring the bondholders to wait until the get paid. What if any interest rate they are getting is unclear.
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Old 12-15-2010, 11:11 PM   #14
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So if you are government official and your government has borrowed too much money you have two bad choices. Option 1 telling the bond holders to go pound sand, even if that means nobody is going to lend you a dollar for a generation. Option 2 tell the rioting citizen, sorry it sucks but benefits are cut, and taxes are raised. I think as more and more people realize that option 1, although unthinkable a few years ago, is actually an a viable option we are going to see investor demand a risk premium for loaning money to governments.
Nice write up. For the USA - short term 5+ years:
Cutting benefits - not going to happen
Increasing taxes - only for the rich - everyone says it is the wrong thing to do in a recession.
My guess is that the Feds & the government does nothing - interest rates go up - bonds and stock market down would result; the opposite of what the Fed is trying to do. There just aren't any options out there.
QE2, the extension of the tax cuts and Spain/Greece/Portugal worries are probably on investors minds.
I still don't see this resulting in inflation. It will be offset by a slowing economy.

In Europe, they will cut benefits and raise taxes like in Greece and Ireland.
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Old 12-15-2010, 11:24 PM   #15
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fwiw i would not buy muni bonds or muni bond funds because i don't trust the city or state issuing them to be solvent. i am be wrong but i view munis as a very dangerous place very similar to junk bonds.
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Old 12-15-2010, 11:54 PM   #16
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Let's not exaggerate. There are cities and states out there in good financial standing. The city where I live has recently cut services, laid off employees, and raised fees in order to close the municipal budget gap and it is now AAA-rated. Too many headlines focus on the bad apples.
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Old 12-16-2010, 05:55 AM   #17
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The county I live in is AAA rated as well. The power to tax is very highly credit-enhancing.
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Old 12-16-2010, 08:40 AM   #18
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so if a municipal bond is defaulted, does the bond holder get to sue in bankruptcy court for city assets? (land, buildings, etc.)?
The bond holder becomes a general creditor if the entity issuing bond is liquidated.

Always a good idea to focus on the ratings of the bonds you hold... ratings are not static- they can and do change, and watching that is important to know credit quality.

Another point would be focus on General Obligation bonds, which are considered safer than revenue bonds.
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Old 12-16-2010, 08:45 AM   #19
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The county I live in is AAA rated as well. The power to tax is very highly credit-enhancing.
And thus the distinction between GO bonds and revenue bonds. The former are usually considered "safer" as they are backed by the government's power to tax while the latter are dependent on the success of the project being funded and are not backed by that same power to tax.
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Old 12-16-2010, 09:36 AM   #20
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And thus the distinction between GO bonds and revenue bonds. The former are usually considered "safer" as they are backed by the government's power to tax while the latter are dependent on the success of the project being funded and are not backed by that same power to tax.
There are plenty of revenue and agencyu bonds I would happily buy. I'd be more than happy to buy NY/NJ port authority bonds at the right price. They are backed bythe authority's ability to levy tolls on all the NYC bridges and tunnels.
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