LIPPER SENIOR RESEARCH ANALYST DON CASSIDY ON KTLK AM-760
Thursday, Oct. 25
Q. While the stock market HAS rallied for the last four weeks, many peopleare still skittish and want to think "safety," and BOND funds...A. Right. So maybe today we should look at bond funds.
Q. First of all, Don, what are the advantages of a bond FUND overindividual bonds?
A. We start with diversification to reduce risk: for a few thousanddollars you could have pieces of a couple of hundred different bonds. Itis tough to buy individual bonds in blocks of less than $25K, and thenyou'd have single-issuer risk.
Q. What else?
A. Well, in a fund you can have a variety of bonds of differingmaturities, so you are not exposed entirely to one part of the yield curveas with a single bond. And of course you are getting professionalmanagement... and you can redeem a small piece if you have a dental bill orsome other cash need. Can't exactly sell $1,300 of bonds...
Q. But what about expenses?
A. They come with every fund, of course. The average is about 52 basispoints for advisor fees, and under 80 basis points overall. That DOES cutinto your yield, but I think it's a small price to pay for the advantages.
Q. Should investors think about bond FUNDS the same way they think ofbonds themselves?
A. Excellent point. Answer: except for looking for quality, no. Theindividual bond has a maturity date. So if you are retiring in 8 years orlooking at paying tuition in 18, a quality bond can be bought that willmature at full face value at that time. A fund HAS NO maturity -- it isconstantly maintaining roughly the same average maturity by replacing bondsas they come due. So a fund is MORE sensitive to changing market yieldsthan an individual bond is, since it always has a long maturity, forexample. AND, one bond has a fixed coupon rate. But a bond FUND keepsbuying and selling bonds, so over time your yield will change with theportfolio.
Q. Let's focus now on municipal bond funds; we noticed a lot of CLOSED-ENDmunicipal funds have come to market this year...
A. Right. 25 funds and more in the wings to come out this month or next.People like them for several reasons...
Q. Such as...
A. Naturally, their income is free of federal taxes and if it is asingle-state fund, also free of state tax in that state.
Q. But what about the CLOSED-end ones specifically?
A. First, they do not sell more shares to the public, so over time theyield can remain nearly fixed rather than varying when new money needs toget invested at lower rates (in a bond bull market). Second, in a bondbull market these funds tend to trade at premiums over NAV, or at smallerdiscounts than when rates are high. For example, the average closed-endmunicipal bond fund now trades at a 4.5% discount, whereas last December itwas about 11%. Discount give you a little extra cash yield.
Q. Anything else?
A. Definitely: about 80% of the 233 closed-end municipal funds useleverage. That means they borrow money at LOW rates for the short term andbuy long bonds at higher rates. The difference they squeeze out, afterexpenses, raises the yield. Right now there are lots of closed-endmunicipal funds yielding between 5.5 and 6% tax free, which is a lot betterthan 5.3% for a US Treasury bond that is taxable!
Q. Any risks?
A. Absolutely: when you use leverage, the NAV of the fund fluctuates morethan if you do not. So if bond rates rise and bond prices fall, your NAVwill drop faster. In 1994, a lot of closed-end leveraged bond funds wentfrom $16 a share to about $11, because of the bond bear market plus the useof leverage. Painful for a while.
Q. Where can people get information on these?
A. Their yields and premiums/discounts are listed in the WSJ and Barron'severy Monday, and the daily prices are in the WSJ in its new separateclosed-end funds table in section C every day. Many of the major issuerssuch as Nuveen and Merrill Lynch have good info on their websites.
Q. Any local ones, Don?
A. Just one in Colorado: Voyageur Colorado Insured, traded on the Amex.High quality, all AAA and insured, so it will not own any DIA bonds toworry about in the airline business downdraft. Discount to NAV is about3%. Yield is about 5.4%. Ticker is VCF. Not a recommendation of course,but maybe worth a look for some listeners.
