Municipal bond mutual fund flows continued to increase in October, the second straight month of inflows, according to an Investment Company Institute report released last week.

During October, inflows totaled $719 million, making total net assets $379.4 billion. ICI tracks 682 muni bond funds.

This data shows that the muni bond industry is continuing to feed off gains posted in September after reporting losses for three straight months. The October flows are less then the prior month, when $1.51 billion of inflows was recorded.

“August was a bad month, but then in September we improved based on the rally at the start of that month,” said Paul Disdier, director of the tax-exempt securities division at Dreyfus Corp. “After that, people started to get a bit more comfortable and had some cash flows to put into muni funds, so it is likely that this spilled over into October.”

Market stability likely played a role in the continued interest in muni funds during this time, as yield levels did not vary as much as they had in the past.

“Cash flows continued throughout October because that month continued to be pretty flat, so you aren’t likely to have a lot of redemptions, and on top of that, there wasn’t a lot of bad news during that time to make for a lot of redemptions,” Disdier said.

Municipal Market Data’s triple-A yield curve demonstrates the lack of volatility. On Oct. 1, the yield scale read 3.79% for a 10-year bond, on Oct. 31, it read 3.81%. Thirty-day volatility on Oct. 31 was 10 basis points for bonds maturing in 10 years. The yield scale for bonds maturing in 30 years is similar. On Oct. 1, the yield scale read 4.42%, and on Oct. 31, it read 4.40%. The 30-day volatility was 12 basis points at the end of the month for 30-year bonds.

Total returns were also up. Lipper Inc. tracked 247 “general” muni debt funds that between Sept. 30 and Oct. 31 had a total reinvested performance of 0.28%. This same category returned 1.34% in September. In June through August — when outflows were reported — performance was negative for each month. It reached a climax in August, when general muni funds returned negative 0.96%.

August troubles were a result of news of the subprime default crisis beginning to affect the municipal market. This subsided through October, creating a temporary calm before the storm. In November, news of several monoline insurers and broker-dealers having mark-to-market losses and write downs rattled the muni market, which subsequently weakened dramatically.

“What happened was that in August the markets were focused on the news of the bond insurers and their exposure to subprime coming out,” said John Mousseau, vice president and portfolio manager at Cumberland Advisors.

“After this, there was not much news except for a trickle of information on the monoline insurers during October,” he said. “During this time, the market tended to discount the worst, and there was a big disconnect between the insurers and the news on the insured bonds. The news on the insurers was bad, the stock prices reflected that, the credit default swaps reflected it, but the insured municipal bonds did not reflect it — instead, it lagged until November when everything happened very quickly.”

Supply was high in October, likely a result of a stable market. According to Thomson Financial, during the month $44.1 million was issued through 974 transactions, the fourth highest month this year through November.

“Investors ate it up,” Mousseau said. “The supply came when the market had a lot of stability too, so a lot of funds viewed this stability and supply as a means to get past the problems of August. This was fine and well until November came around.”

Tax-free money market funds increased assets under management by 2.8%, to $434.5 billion of short-term bonds. This is a result of the Federal Reserve cutting the federal funds rate by 75 basis points to 4.50% in the past two meetings of the Federal Open Market Committee. The Money Fund Report noted in its Oct. 31 issue that as this occurs, investors unsure of future movements will buy into these traditionally safe investment vehicles.

Taxable money market funds increased assets under management by 4.3%, to $2.54 trillion in assets under management.

Taxable bond funds had inflows also that amounted to $10.9 billion, up from inflows of $5.9 billion in September. Total assets under management equal $1.29 trillion in the 1,298 funds ICI monitors.

Stock funds had inflows $11.26 billion, up from inflows of $7.49 billion in September. Total assets under management in this fund category were $6.99 trillion in the 4,730 funds that ICI follows.

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