Buy Side

Muni Funds Enjoy Big Inflows

Fat yields, low inflation, and a turbulent stock market led to the largest cash influx into municipal bond mutual funds in more than half a year.

Muni funds that post weekly numbers reported inflows of $737 million during the week ended Jan. 14, the most since the final week of May, AMG Data Services reported last week.

The previous week's $208.1 million inflow was the first time in nearly four months investors put more money into muni funds than they took out, according to the Arcata, Calif.-based fund tracker.

The fund inflows follow a rally in the muni market that began last month. The Bond Buyer municipal bond index is now at 103.3, up from less than 92 in mid-December.

"There have been four consecutive weeks of positive market action," said Robert Adler, president of AMG Data. "That's giving investors some encouragement that they would be coming in on a trend where the after-tax return on municipals may have been opportunistically high."

Muni funds suffered substantial outflows during the worst of last year's credit crisis. Investors dumped munis along with nearly every other asset class in a wholesale flight to safety.

Investors withdrew nearly $2.3 billion from municipal funds in a single week in mid-October. Combined assets of all muni funds - including those that report figures monthly - shrank from $397.5 billion in early September to $338.1 billion last month.

The yield on a triple-A rated, 10-year general obligation muni has compressed 139 basis points since Dec. 10, according to Municipal Market Data.

A 10-year, triple-A muni now yields 127.6% of a 10-year Treasury. While this remains far above the historical norm, it represents a significant convergence since the relationship distended to 186% last month.

Chris Mier, managing director at Loop Capital Markets LLC, said investors were not content to sit back and watch the net asset values of their muni funds shrink during the credit crisis.

While investors may be willing to brook losses in stock funds, they mistakenly believe municipal funds are shielded from such declines, he said. This prompted them to sell.

Investors are now looking at unusually high yields on munis relative to inflation and Treasury rates, which create an attractive entry point, Mier said.

"Now they're looking at a muni product with a low NAV, with an expectation that NAVs are going to rise," he said. "You're going to get cash flow in that environment."

A raft of factors make munis attractive, according to Mier:

* Consumer prices last year climbed at the slowest rate in more than half a century, the Labor Department reported Friday. When inflation is low, coupon payments on munis are worth more. Municipal yields relative to inflation are the highest in decades, Mier said.

* Treasury rates remain paltry. U.S. government bonds began rallying again last week after a short sell-off. The 10-year Treasury yielded about 2.3% on Friday, compared with 4% in October.

* Shocks continue to plague the stock market. The Standard & Poor's 500 Index tumbled 7.1% in the seven days reflected in AMG's report.

* While Mier said corporate bond yields are attractive, investors in corporate bonds have to worry about default rates. Munis' historically slim rate of defaults means investors can pick up good yields without the credit risk of corporate bonds, he said.

Sheila Amoroso, co-director of the municipal bond department at Franklin Templeton's fixed-income group, said another impetus pushing buyers into the market is the prospect of federal government support.

"It's looking like the federal government is going to help state governments, and that's giving people a higher degree of comfort," she said.


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