For the past seven years, Peter Demirali has urged clients to put money into taxable municipal bonds — a small, neglected sector of the industry.

Suddenly, the Cumberland Advisors portfolio manager finds himself his firm’s point man for the hottest sector in munis.

Build America Bonds have catapulted taxable munis — an asset class long ignored by tax-paying and tax-exempt investors alike — to the forefront of public finance.

Demirali, who manages $250 million of taxable munis at his Vineland, N.J.-based company, believes the expansion of the taxable sector is attracting new types of investors and creating a liquid alternative to corporate or agency bonds.

“We knew when they made this announcement that it was going to be huge for the public finance industry,” he said.

BABs allow state and local governments to sell taxable debt and receive a subsidy from the federal government or pass the subsidy along to the investor.

The pricing of the deals so far has offered issuers — including California, the New Jersey Turnpike Authority, the University of Minnesota, and the University of Virginia — cheaper financing than the traditional tax-exempt market.

The New Jersey Turnpike, for example, last month priced $1.38 billion of BABs maturing in 2040 at a yield of 7.41%. A 35% federal contribution of that means the Turnpike is paying a yield of 4.82%.

At the same time, the Turnpike priced callable tax-exempt paper with the same maturity at a yield of 5.35% — more than 50 basis points higher.

“It allows municipal bond issuers to come to market and basically reduce their interest cost significantly,” Demirali said.

That is all well and good for the issuers. But Demirali thinks BABs are attractive to investors too, for a few reasons.

BABs offer investors that have not traditionally bought munis an extra tool for diversification, he said. A fund that invests in corporate debt and mortgage-backed securities, for instance, can add munis to achieve a better array of bonds.

Because BABs are appealing to a variety of new investors — pension funds, tax-exempt trusts, endowments — they also offer the prospect for more liquidity in a notoriously illiquid asset class, he said.

So far, BABs have been trading at bid-ask spreads of about three basis points, Demirali said. He expects that liquidity to last.

One of the reasons many qualified investors have not traditionally bought taxable munis is they come traditionally from small and illiquid issues.

“Now, you have an asset class that has become much more liquid and much more tradeable,” he said.

Third, default rates on munis are minuscule compared with corporate bonds. Now that taxable munis are coming in substantial supply, BABs can compete with corporates for investors’ money.

Demirali said his funds have already attracted more investor inflows, and he anticipates those inflows will continue.

Demirali points out the credit quality of BABs is further fortified by the federal subsidy. One-third of the interest payments on BABs come from the U.S. Treasury — the strongest credit in the world.

Demirali, who worked at Smith Barney for 10 years before joining Cumberland, measures the relative value of BAB yields in two main ways.

One, he looks at the spread over Treasuries with comparable maturities.

The New Jersey Turnpike deal priced at a spread of 370 basis points over the Treasury bond. Since then, the spread has narrowed to 290 basis points.

Demirali expects GO BABs generally to trade at a spread of 325 to 330 basis points over 30-year Treasuries.

Second, he compares BAB yields with similarly rated corporate bonds.

“They’ve just been stellar performers,” he said.

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