The Moody's Investors Service downgrades of Ambac Assurance Corp. and Berkshire Hathaway Assurance Corp. this month highlight the new paradigm for insured municipal bond funds. They are now not all that different from plain muni funds.
Insurance is playing a rapidly shrinking role in the public finance industry. About 13% of new bonds coming to market this year are insured.
Further, market participants say insurance from many carriers adds little if any value to a bond. At certain times last year, insured bonds actually traded at higher yields than uninsured bonds with the same credit quality.
Yet mutual funds and trusts that by mandate populate some or all of their portfolios with insured bonds have not collapsed.
Some have adjusted, some have merged into plain funds, and some have been able to continue without much noticeable difference.
"I'm not sure that it had a huge effect," Jeff Tjornehoj, fund analyst at Lipper Inc., said of the insurance industry turmoil's impact on insured funds.
Managers say the shakeout in insurance has placed an emphasis on underlying credit quality, although underlying credit was always crucial.
Whereas until 2007 an insured portfolio meant a top-notch rating and supreme credit safety, it now means the portfolio is as strong as the credit quality of the issuers it owns.
What is different about insured funds, said Robert MacIntosh, who manages insured funds at Eaton Vance, is the possibility of better price performance should the market eventually recognize the value of insurance.
"I would argue that insured bonds could represent tremendous value right now," he said. "The insurers we're using here are not gone. They're still there. It's still worth something. Someday the market may come to realize that. If that's the case, we have a bunch of bonds in these insured funds that are poised for some relative outperformance."
In the meantime, Eaton Vance has changed the terms of its prospectus for the insured funds, which are required to have 80% of their bonds carry insurance.
The funds are now permitted to use any insurance rated triple-B or better to achieve this ratio, while previously it was restricted to triple-A.
The downgrade of Ambac did not affect these portfolios because the mandate is based on the highest rating among the three agencies. While Moody's now rates Ambac Ba3, Standard & Poor's still rates it single-A.
The Eaton Vance Insured Municipal Bond Fund has rebounded 21.4% this year after tumbling 37.2% last year.
Another vehicle that changed its criteria so that the insurance downgrades did not upend its investment strategy is the Invesco Powershares Insured National Municipal Bond exchange-traded fund.
The ETF now is limited to bonds with insurance rated two notches below the average composite rating of the Merrill Lynch US Insured Bond Municipal Securities Index. The fund previously required bonds with insurance the rating of which averaged triple-A from the three ratings agencies.
The ETF is up 5% this year after slipping 15.8% last year. Philip Fang, who manages the ETF, said it is not having trouble raising new money from investors. The fund has $278.1 million in assets.
"People still do understand that [with] monoline insurance, even though it's been downgraded, you're basically wearing belts and suspenders," Fang said.
Salvatore DiSanto, who manages the Narragansett Insured Tax-Free Income Fund, said his fund is restricted to insured bonds. Whether the insurance on those bonds is rated triple-A or junk does not affect that restriction.
That means the upheaval in bond insurance has not significantly altered his holdings or his strategy.
"We haven't changed the fundamentals," he said. "The insurance was always an added layer of security and a buffer. ... You don't buy a bond because of the bond insurance. You have to know the underlying level of credit is."
The fund is up 2.3% this year after slipping 2.4% last year.
Not everyone chose to stick with the insured model. Last year, Vanguard merged its long-term insured fund into its regular long-term tax-exempt fund.
The company at the time explained in a statement that a fund focused only on insurance "no longer provides tangible benefits."