Municipal bond yields are at or near all-time lows, but it’s no thanks to muni mutual funds.

Muni investors have been taking cash out of funds for most or all of the past six weeks, depending on who is counting, leaving market participants left wondering where the money is going in this low-rate environment.

The spark prompting outflows is relatively clear: investors in late July were deeply uncertain about what impact the debt ceiling debate would have on the muni market. But why outflows persist is a bit more hazy.

Lipper FMI, which tracks $331.6 billion of muni fund assets, has reported six weeks of outflows beginning with a $130 million draw-down in the week ending July 27. Weekly outflows in the period peaked at $861 million in early August, tapered to as little as $148 million in the week ending Aug. 24, then widened to $282 million in the final week of August.

The trend is “unsettling” to Chris Mauro, head of research at RBC Capital Markets.

He noted in the first three reporting periods of August, several major asset classes including corporate debt and equities reported net outflows. Equities and taxable debt funds then rebounded for two straight weeks, while muni funds kept bleeding.

“Munis seem to be the only asset class squarely out of favor with mutual fund investors,” he wrote Friday.

Scott Cottier, senior portfolio manager of the Rochester muni group of OppenheimerFunds, said investors continue to pull out of muni mutual funds because of broader market volatility. He conjectured that buyers, who purchase funds for  steady income streams, might rather be on the sidelines until markets become calmer. Or they may be sensing a bottom in the equity market and want to be ready to jump in.

Worrying as the outflow trend might be, the recent withdrawal figures are little more than knee scrapes compared to the six months of hemorrhaging from November to May.

Lipper’s four-week average of outflows is currently $359 million, and total outflows in the six weeks stand at $2.43 billion. By contrast, weekly outflows were as much as $4 billion in January, shortly after banking analyst Meredith Whitney warned of widespread municipal bond defaults on prime-time television.

The Investment Company Institute, which looks at $465 billion of muni assets, has recorded outflows in five of the six weeks since July 27, including more than $1 billion for the week ending Aug. 10. Unlike Lipper, ICI posted net positive flows for the week ending August 31, with $227 million, as reported Wednesday.

The data is broadly telling the same story, but there are a few differences.

Mauro pointed out that in Lipper’s most recent data, long-term bond funds were again hit the hardest, whereas inflows were highly concentrated in the short and intermediate subsectors.

But Brian Reid, ICI’s chief economist, said his data doesn’t show any trend of investors moving from the long end to shorter funds. Rather, he noticed that outflows are no longer uniform, as they were from November to May, but state-specific.

“What we’re seeing now is a shift out of state funds and into more of the national funds, and they have roughly offset each other,” Reid said.

In ICI’s July data — the latest that is available — state-specific funds saw $646 million of withdraws, whereas national funds saw $670 million of inflows.

Muni investors tend to buy local debt for maximum tax-benefits — New York City bonds, for instance, offer a triple-whammy exemption from city, state, and federal taxes for city residents — but national funds can offer greater diversification.

“There could be some state-specific issuers that investors are concerned about,” Reid said. “This could be a way to move away from exposure to a particular set of municipalities in a single state.”

EPFR Global, which tracks $450 billion in muni fund assets, shows six weeks of outflows. Withdrawals peaked at $795 million for the week ending Aug. 3, slowed to $17 million for the week ending Aug. 24, then expanded to $375 million.

“A fair number of retail investors are still putting money in munis, but doing so directly rather than going the fund route,” said Cameron Brandt, director of research at EPFR.

Indeed, light supply and strong demand pushed Municipal Market Data’s 10-year muni yield to an all-time low of 2.09% on Wednesday. It has now dropped 59 basis points over the same six weeks that funds reported outpourings. The two-year and 30-year similarly fell 10 and 67 basis points, respectively, to 0.30% and 3.68%.

Chris Shayne, senior market strategist at BondDesk Group, said the diametric trend between muni mutual funds and individual bonds isn’t abnormal.

He noted the “sell funds, buy bonds” trend was in place during the stampede from muni mutual funds earlier this year, even calling it a “feeding frenzy” among buyers happy to pick up the extra yield.

More recently, buyers of individual bonds were nervous in early August but by the end of the month the number of buy-to-sell trades jumped to 2.6 — versus a calendar-year average of 2.4. And despite the muni rally, tax-exempts haven’t kept up with Treasuries, so muni-Treasury ratios remain attractive. The two-year ratio is 150% and the 10-year is 103%.

“Munis are extremely cheap relative to Treasuries, and high-yield munis are extremely cheap relative to high-grade munis,” Oppenheimer’s Cottier said. “So if you’re investing in the muni market, the value play is investing into long-term, high-yield municipal securities.”

That argument goes for buyers of individual bonds or funds; what funds offer is reduced credit risk thanks to diversification. The difference is an individual bond has a clear maturity date, a fund does not. Rising interest rates would push both the value of the bond and the values for fund shares lower.

Michael Zezas, muni strategist at Morgan Stanley, wrote Tuesday that the muted outlook for growth and inflation should keep Treasury yields “roughly flat” through the end of 2012, which should support stable demand for mutual funds.

“Demand for muni mutual fund investments should stabilize as investors capitulate to the lower-for-longer rates view and, accordingly, become less concerned about the constant duration risk in owning mutual funds.”

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