October 19, 2011
The managers of T. Rowe Price's municipal bond funds recently shared their views on the opportunities provided by municipal bond funds in shareholder reports covering the six months ended August 31, 2011.
T. Rowe Price's municipal bond fund managers—Hugh McGuirk, Charlie Hill, Konstantine (Dino) Mallas, Jim Murphy, and Joe Lynagh—offered the following insights:
- Tax-free municipal bond funds may currently be a very attractive investment opportunity, particularly for mutual fund investors in high tax brackets seeking ways to reduce their taxes.
- As Treasury yields have fallen sharply, municipal bonds lately have been offering higher yields than taxable U.S. government bonds. This is an unusual situation given that most mutual fund shareholders and other investors do not have to pay taxes on municipal bond income and, therefore, do not usually demand higher yields from municipal bonds.
- The performance of municipal bond funds this year has been driven by several factors, including a significant year-over-year decline in municipal issuance, falling Treasury yields, and the Federal Reserve's very accommodative monetary policy.
- While last year's dire predictions about massive municipal defaults in 2011 proved to be alarmist, some mutual fund investors may still be worried about the potential for municipal bond defaults. We believe many states deserve the high ratings that they have been given by the major credit rating agencies, and we do not see a near-term threat to their ability to continue servicing their outstanding debts.
- Still, municipal bond defaults, which historically have been rare, could increase moderately because of the weak economic recovery. However, defaults thus far have been mostly limited to the smallest issuers in the riskiest of sectors.
- While T. Rowe Price's municipal bond fund managers have longer-term concerns about state finances, they note that the fiscal woes of state governments do not necessarily limit municipal bond investment opportunities. There are thousands of unique municipal issuers in a variety of sectors, many of which also have good credit profiles.
- We believe that T. Rowe Price's strong independent credit research has been and will remain an asset for our mutual fund shareholders. As part of our mutual fund management process, we continue to conduct our own thorough research and assign our own independent credit ratings before making investment decisions.
Some municipal bond fund income may be subject to state and local taxes and the federal alternative minimum tax. Yield and share price will vary with interest rate changes. Investors should note that if interest rates rise significantly from current levels, bond fund total returns will decline and may even turn negative. Past performance cannot guarantee future results.