Tax Exempt Bonds
The tax exempt or tax-free bond market saw reasonable results in 2009, particularly in the second half of the year. However, when compared to the returns many investors were getting in the stock market during 2009, the results in the tax exempt bond sector aren’t overly impressive. But it is important to keep in mind the differences in investment objectives of owning tax exempt bonds as opposed to stocks or other securities. Unlike owning stocks, bonds are usually held as a fixed income producing asset.
A tax exempt bond is a bond generally issued by a State or municipal government, and the interest earned from holding these bonds is not subject to Federal, and in many cases, State and local income taxes. And due to this special tax treatment for these bonds, many investors will actually realize greater returns with tax exempt bonds than other bonds or securities when their marginal tax rate is figured into their return on investment. Additionally, tax exempt bonds are generally a much safer and secure investment than taxable bonds or stocks.
It is interesting to note that most tax exempt bond funds outperformed treasuries during 2009, which is not the normal historical trend. So if you think that tax exempt bonds might be a good in your portfolio, you may be wondering what the future holds for the tax exempt bond market.
“We believe that technical factors will remain supportive for the municipal market going forward,” said Steven Permut, leader of the municipal bond team at American Century Investments. “The more taxable municipal bonds issued under the Build America Bond program—a federal government program intended to help lower municipal borrowing costs—the lower the supply of tax-free municipal bonds. In addition, we think demand for municipal bonds is likely to remain strong given that the Federal Reserve continues to hold short-term interest rates at record lows and municipal yields are attractive relative to those on Treasuries.”
However, Permut’s outlook comes with a caveat: “Economic fundamentals remain fairly weak, and we think tax-based bonds and those issued by local governments are likely to face challenges.”
As any good investor should always do, study the holdings of each tax exempt bond fund you are researching. Review the performance of the investment team, and compare how they have managed their fund in relation to the Lipper group and GO Index.
February 21st, 2010 at 12:37 pm
Seems like the term “Bubble” in relation to any asset class is this years equivalent to 2007’s term “a perfect storm”. It’s a great term for cocktail party conversation but it isn’t particularly useful in assessing an investment strategy. A bubble is only recognized in hindsight. People were predicting a real estate bubble as early as 2000. It wasn’t until 2008 that the prediction came true. Every asset class with returns that exceed the long term averages is a potential bubble.
February 21st, 2010 at 1:35 pm
I really don’t understand what people mean when they talk about a “bubble” in the bond market. Bonds aren’t tulip bulbs. Why not just say that interest rates are pretty low right now, and it seems that interest rates are more likely to rise than to fall in the near to intermediate term? “Just check the duration. That’s a technical term that’s the best measure of a bond’s inflation and interest-rate risk.”