Be Careful When Considering Municipal Bonds


A recent Wall Street Journal column advises money managers not to put more client money in municipal bonds. The column sets forth a number of risks and problems that it urged money managers to consider before placing clients’ money in these investments.

First, municipal bonds’ tax-exempt status may be in political jeopardy (“Morning Call: Advisers Stuck Playing a ‘Dangerous Game’ in Munis,” by Kevin Noblet).  Politicians, always sensitive to public criticism, are looking for ways to increase government revenues without increasing income tax rates.  One such indirect means of increasing revenue would be to eliminate the exemption from federal income tax enjoyed by municipal bond investors.  The fact that this would tend to impact more affluent citizens is even better politically and makes such a move more likely to actually happen.

Second, state and local governments are apparently still suffering from revenue shortfalls and budget cuts that increases the risk of default.  Historically, defaults have been extremely rare.  Defaults by municipal bond issuers have become less rare, though they remain rare.

Another potential issue is the maturity of the municipal bonds in question. The longer the maturity, the greater the sensitivity to an increase in interest rates.  Also, municipal bond funds that have “short-term” in their name may not actually be short-term.  Investment advisers should “look under the hood” and make an independent determination of the average maturity and duration before committing clients’ money to such an investment.

The column concludes that the inevitability of an interest rate increase at some point in the future makes municipal bonds “a dangerous game to play.”

Page Perry is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.