Nuveen Investments' John Miller, the No. 2-ranked municipal-bond fund manager of the past five years, had a tough 2007 because he kept almost...

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Nuveen Investments’ John Miller, the No. 2-ranked municipal-bond fund manager of the past five years, had a tough 2007 because he kept almost half his assets in unrated securities as prices sank.

As of Oct. 31, Miller had invested 48 percent of the $5.1 billion Nuveen High Yield Municipal Bond Fund in nonrated bonds that finance projects such as schools, hospitals and water-treatment plants, compared with 29 percent for rivals, according to data from Morningstar. Seventy percent of the fund is in below-investment-grade bonds.

The strategy backfired when investors fled all but the highest-rated government bonds as subprime-mortgage losses mounted.

The fund, which Miller took over in 2000, fell 5.1 percent through Dec. 18, ranking 19th of 25 rivals tracked by Bloomberg.

Its annual average return of 6.5 percent in the past five years ranks second behind the $8 billion Oppenheimer Rochester National Municipals, and Miller isn’t switching gears.

“We’re not in the business of repositioning between high-grade and high-yield,” Miller said in an interview from his office in Chicago.

Spreads between yields on AAA municipal bonds and unrated debt widened about threefold to 2.5 percentage points, Miller said. The spreads reflect “psychology and fear” that has rippled through debt markets, the manager said.

Delinquencies on subprime mortgages — loans made to the riskiest borrowers — reached a 20-year high in the third quarter, according to the Mortgage Bankers Association in Washington.

Those loans, repackaged and combined with other fixed-income securities, infected investments that prompted banks such as Citigroup and UBS to write down about $80 billion in losses.

Besides nonrated municipal debt, Miller’s fund holds mostly below-investment-grade, or junk, municipal bonds rated less than BBB- by Standard & Poor’s and under Baa3 by Moody’s Investors Service. Eleven percent is in investment-grade-quality securities, compared with 25 percent for the average high-yield muni fund, according to Morningstar.

“It’s a very worthwhile fund, but clearly it was taking on more risk than its rivals,” Morningstar analyst Greg Carlson said.

Morningstar gives the fund four stars out of a possible five. Its three-year Sharpe ratio is 0.09, compared with minus 0.04 for the peer group. A higher Sharpe ratio means better risk-adjusted returns.

Nuveen, which was taken private in 2007 by Madison Dearborn Partners, also of Chicago, has $170 billion in assets under management. The company runs five other municipal-bond funds, all of which are designed to carry less risk than the high-yield fund.

Nuveen High Yield’s largest holdings include a Baa1 bond for the Baptist Medical Center in Birmingham, Ala., a nonrated issue funding a monorail construction in Las Vegas and a CCC+/Caa1 bond sold by automaker Ford through the Ohio Environmental Facilities Authority.