Retail demand for municipal bonds continued to surge last week as mutual funds that invest in state and local government debt posted their second biggest weekly inflow of the year.

Municipal bond mutual funds that report their figures weekly reported $953.9 million in new money from investors during the week ended Aug. 11, according to Lipper FMI. That was the biggest weekly inflow since March, and heavier than all but 33 inflows since Lipper started tracking the data in 1992 — 970 weeks ago.

Among all funds, including those that report their figures monthly, inflows have averaged $1.07 billion a week the past four weeks. This is the first time the four-week average has exceeded $1 billion in more than four months. With market gains, muni fund assets grew 0.6% last week to a record $512 billion.

“The positive trend continued as muni mutual funds enjoyed very strong net inflows,” Chris Holmes, a municipal an analyst at JPMorgan, wrote in a note to clients.

Generally seen as a proxy for retail demand for municipal bonds, mutual fund flows have rebounded since April.

Investors entrusted $69 billion to municipal funds in 2009, according to the Investment Company Institute, easily a record.

Flows began to slow down in April this year, when funds posted less than $1 billion in net inflows in a month for the first time since December 2008.

May and June were also sluggish by recent historical standards, with respective net inflows of $2.66 billion and $1.95 billion — also slower than any month since the beginning of 2009, except this past April.

Last month flows began strengthening again. Funds reported taking in about $4 billion in July, according to preliminary weekly data from ICI.

“It’s picked up again lately,” said Dan Solender, director of municipal bond managent at Lord Abbett.

Lord Abbett runs 12 municipal funds with more than $7 billion in assets.

Solender said because expectations are that the Federal Reserve’s target for interest rates will remain near zero well into next year, people are growing increasingly comfortable with the yields offered on municipal bonds — even though they have never been lower.

The yield on a 10-year triple-A rated municipal bond sank below 2.5% for the first time last week, according to Municipal Market Data.

The 10-year triple-A yield has plunged 30 basis points this year and more than 110 since the beginning of 2009, based on the Municipal Market Advisors scale.

With the two-year Treasury yield at 0.5% and tax-free money market rates at 0.03%, Solender said muni rates by comparison do not seem so bad, especially on a tax-equivalent basis.

“Given all the different alternatives out there, municipals definitely seem to be a fair to attractive value,” he said.

The robust performance of municipal bonds led funds to report $1.76 billion in market gains on their holdings last week. Funds’ market gains for the year now total $21 billion.

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