T. Rowe Price recently launched an Intermediate Tax-Free High-Yield Fund targeting investors who are worried about protecting their principal in the face of potentially higher interest rates yet comfortable with some extra risk.
The open-ended fund, whose inception date is July 24, 2014, trades under the ticker symbol PRIHX. It will generally maintain a weighted average effective maturity of between three and 10 years, and seeks to provide a high level of income exempt from federal income taxes,- primarily through investments in intermediate-term, lower-quality municipal securities, according to its prospectus.
The launch of the fund comes after a drop in lower-rated issuance that led the $6.74 billion Invesco High-Yield Municipal Fund to close to new investors on Aug. 1.
According to Bloomberg data, issuance of lower-rated bonds fell to $900 million this year through July less than half of the $2 billion issued over the same period last year.
Although weekly flows into high-yield funds dipped to $227.2 million from $307.72 million as of July 31, assets increased to $443 billion from $440 billion the week prior, according to Lipper FMI data. The four-week moving average flow improved to negative $53.9 million, from negative $109.3 million.
Municipals' outperformance and relative attractiveness compared to Treasuries so far in 2014 contributed to T. Rowe Price's timing of the fund's launch, according to a July 31 report.
"Munis have come a long way, and the market has righted itself to more traditional levels," said James M. Murphy, a 30-year industry veteran and manager of the new fund, in the report titled "Municipal Bonds Make a Comeback."
"We still think they offer value," especially for investors in high tax brackets, according to Murphy, who has been with T. Rowe Price since 2000 and also manages the T. Rowe Price Tax-Free High-Yield Fund.
He said municipals posted an average return of 6% in the first half of 2014. The average yield in the municipal market declined from 3.15% at the end of 2013 to 2.35% as of June 30, which aided strength, Murphy suggested.
The market has been supported by favorable supply and demand trends for municipal debt "as there has been less issuance of new bonds and investor demand has stabilized," Murphy said in the report.
Murphy said credit analysis will remain a key component in managing the new fund as investors will have to absorb extra market, credit, interest rate, active management, and liquidity risks while earning potentially higher tax-free yields.
It intends to invest a substantial portion of its assets in municipal bonds that are rated noninvestment -grade - such as those with a BB rating and lower, or an equivalent rating.
It will also invest in unrated bonds, and may buy bonds in default, as long as they do not exceed 10% of the fund's total assets. The fund may own bonds from sectors with special risks, such as health care, transportation, utilities, or private activity bonds, according to the prospectus.
Murphy noted that about 20% of the fund is invested in corporate-backed tax-exempt securities "because the firm is able to take advantage of the higher yield due to its strong credit research."
He said the firm had minimal exposure to Puerto Rico during its deterioration in recent months thanks to advice from its analysts.
"We still believe the municipal bond market remains a high-quality market that historically has had very low default rates. Fundamentally, the credit environment for municipalities is sound and should improve with the economy," he added.
He said there is still opportunity to be had due to the relative attractiveness of municipals to Treasuries, even though rates have defied expectations and fallen in the midst of continued tapering of bond purchases by the Federal Reserve Board.
"We think rates are going to be lower than normal for an extended period," he said. "Even if the Fed is getting out of the tapering business the economy is still pretty sluggish and inflation is not a problem."
