The normally staid municipal bond market has been rocked by the credit crunch, but analysts say the resulting yields are hard to resist...

Share story

The normally staid municipal bond market has been rocked by the credit crunch, but analysts say the resulting yields are hard to resist.

“Municipals are as attractive now as they have been over the past 15 years,” says James Colby III, senior municipal strategist for Van Eck Global, which offers mutual funds and exchange-traded funds focused on municipals. Even funds specializing in taxable bonds are now buying munis.

Municipalities issue bonds to finance general expenses as well as projects such as sewer systems. They’re favored by investors in high-income brackets. Defaults tend to be rare — Orange County, Calif.’s bankruptcy filing in 1994 was a notable exception — as governments can raise money through taxes.

Muni bonds have been hurt as bond insurers struggle with spiking corporate bond defaults. “It is no surprise that high-yield bond funds and bank-loan funds are underperforming in this environment, but the underperformance of municipals has been unusual, unexpected and probably not sustainable,” says Stifel Nicolaus analyst J. Jeffrey Hopson.

In recent weeks, hedge funds, which invest with borrowed money, had to raise cash to cover margin calls and did so by selling muni holdings, exacerbating the sell-off. Yields rose to record levels compared with Treasurys, says JPMorgan analyst Alex Roever.

“We believe this liquidation phase will be relatively short-lived given the relatively small number of levered investors in this market,” he says.

Indeed, muni prices rebounded last week.