Tags: Sloan | Muni | Bonds | Overpriced

Fortune’s Sloan: Avoid Overpriced Municipal Bonds, Bubble Forming

Tuesday, 18 Dec 2012 01:49 PM

Investors have flocked to municipal bonds to take advantage of their tax-exempt interest payments and general safety. Be careful, said Fortune magazine financial columnist Allan Sloan, as prices may be bubbling.

"I want to warn you — yet again — about the perils of buying bonds at current prices. You should be especially wary of muni bonds trading at fat premiums above face value," Sloan wrote in his column appearing on CNNMoney.

Many municipal bonds may be redeemed earlier, and with prices high, early redemption can sting investors.

Editor's Note: Startling Proof of the End of America’s Middle Class. Details in the Video

"Here's the deal. Unlike U.S. Treasury securities and many corporate bonds, lots of investment-grade muni bonds can be — and will be — called in for early redemption by their issuers," Sloan wrote.

"That means that muni bonds' apparent interest yields are way above the actual yield that you'll get if you buy at today's price."

Tax uncertainty continues to confront the country and clouds the future of the asset class as well.

As part of a deal to avoid the fiscal cliff, policymakers are proposing tax hikes on investment income on top of raising income taxes for the wealthy, which has prompted a rush for many to invest in municipal bonds now.

Elsewhere, the president's healthcare reform law carries tax hikes of its own, including on investment income.

Pending tax hikes should prevent investors from selling municipal bonds so they can avoid higher capital gains taxes next year but still, don't rush into a bubbling asset class, Sloan said.

"But make no mistake: Even though people like me aren't selling, anyone with a bond calculator and a knowledge of financial history knows that investment-grade munis like mine are priced at bubble levels," Sloan wrote.

"And that bubbles last longer than you think they will but always pop in the end. And that when boring investments become exciting ones, it's time to keep a firm grip on your emotions — and on your wallet."

Longer-dated municipal bonds in particular have so popular that big funds are now expressing caution.

Longer bonds “have much more downside than upside, and we recommend people trim that part of the curve and come more into that 10- to 15-year maturity range,” said Guy Davidson, who manages $31 billion as director of munis at AllianceBernstein in New York, according to Bloomberg.

Others echoed suit.

"We’re probably a bit more cautious on the market given the recent run that we’ve had,” said Peter Hayes, head of muni debt at New York-based BlackRock, which oversees about $105 billion of the bonds, Bloomberg added.

“So we’ve come back down on the curve.”

Editor's Note: Startling Proof of the End of America’s Middle Class. Details in the Video

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