Municipal bond mutual funds with a lot of airline-related bonds on board took a nosedive during the first quarter, landing at the bottom of Lipper Inc.'s quarterly total return rankings.
The airline sector of the Lehman Brothers High Yield Municipal Index tumbled 18.63% on a total return basis during the first quarter.
Due to a 20.7% weighting in airline-related bonds, the Oppenheimer Rochester National Municipals had by far the worst performance within the high-yield fund category, with its A-class shares suffering a total return loss of 10.23% during the quarter, according to Lipper data. But it took far less exposure than that for other funds to earn the distinction among their respective peer-groups.
A 5% stake in airline-related credits was all it took to sink the performance of the Eaton Vance National Municipals Fund, according to senior Morningstar Inc. analyst Eric Jacobson.
Out of 303 share classes in Lipper's general municipal fund category, the fund came in dead last, with its A-class shares showing a negative total return of 1.89%.
The security behind much of those funds' airline-related holdings has come into question due to a legal challenge introduced during United Airlines Inc.'s Chapter 11 bankruptcy court proceedings that threatens to have facility lease provisions requiring bondholder repayment stayed. United wants the court to rule that the debt is not an obligation under its lease agreements, but instead an unsecured, pre-petition debt.
Bonds backed by the 1998 Master Settlement Agreement between 46 states and tobacco product manufacturers were also a drag on the performance of many funds during the quarter, as future issuance threatened to dwarf demand. The tobacco bond sector was further hurt when on March 22, Altria Group Inc., parent company of Philip Morris USA Inc., was ordered to pay $10.1 billion in a lawsuit over light cigarettes by an Illinois judge. To appeal that decision, state law requires that the company post a $12 billion bond.
The tobacco sector of the Lehman Brothers Municipal Bond Index fell 6.14% for the quarter and has since fallen another 9.89%. The Oppenheimer fund had a 4.7% weighting in those bonds.
In general, more prudent investment strategies paid off. The Minneapolis-based U.S. Bancorp Asset Management Inc.'s First American Tax Free Fund was well diversified. The $550 million fund had over 200 different credits, according to managing director Doug White. "A big commitment in one area can really hurt you," White said.
The fund owned no noninsured airline-related bonds and had scaled back its exposure to tobacco settlement bonds to 0.5% in January, from over 3% in 2002, in response to higher cigarette taxes.
The fund's A-class shares were the seventh-highest in Lipper's general municipal category, with a total return of 1.44%.
None of the six muni bond funds run by Thornburg Investment Management Inc. in Santa Fe, N.M., contains a single tobacco or airline-related bond, according to Josh Gonze, an assistant portfolio manager at the firm.
The discipline it took to constantly turn down those high-yield bonds is finally paying off, Gonze said. "This is kind of our day in the sun," he added. "Our investors are falling over themselves in delight that we don't own any of these bonds."
A-class shares of the firm's Thornburg Intermediate Municipal National Fund had a 1.12% total return for the quarter, ranking 18th out of 144 share classes in Lipper's intermediate muni fund category.
But avoiding the trouble spots wasn't all it took to be a top-performing fund.
Robert Pariseau, an assistant vice president at USAA Investment Management Co. in San Antonio, Tex., made the gutsy move over the past six months of extending the USAA Tax-Exempt Long-Term Fund into longer term bonds maturing in 21 and 22 years.
"It's kind of the kink in the yield curve, where you can get the most amount of income for the least amount of duration risk," Pariseau said.
Yet many funds had taken positions in shorter-term bonds, which would suffer less from a rise in interest rates. But Pariseau was uncertain that the economic recovery would be so swift. Nevertheless, he sold non-callable bonds to limit his duration risk.
The fund turned in a 1.72% total return for the first quarter, the highest in Lipper's general muni fund category.
Joe Deane, a managing director at Citigroup Asset Management Inc. in New York, had taken extremely defensive positions on the bet that interest rates would rise at the end of 2002 and paid a steep price during the first quarter of 2003.
A-class shares of the Smith Barney Managed Municipal Fund had a negative total return of 0.38% for the quarter, near the bottom of the general fund category.
Clark Wagner, director of fixed-income at First Investors Management Co. in New York, was able to capitalize on the fear of rising rates. He had positioned the First Investors Insured Tax Exempt Fund II in premium coupon bonds, which investors have flocked to because they are less likely to fall subject to the market discount rule if interest rates rise. The move helped the fund's A-class shares produce a total return of 1.46%, ranking first among insured funds.
