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Subject:  Re: Municipal bonds: A train wreck waiting to ha Date:  12/6/2012  9:11 PM
Author:  yodaorange Number:  410703 of 481940

This post contains answers to Jgc123 and Crackdclaw.

Jgc123 asked: How do you research muni funds? My Dad has a chunk of PRVAX which provides tax free income at about 3.6% and I can't figure out how to research the relative risks of the individual holdings.

Jgc, I do not know of an easy way to answer this question. I went and downloaded the latest holdings in the fund. Unfortunately, they do NOT list the “CUSIP” for each bond. You have to find that yourself. I did that for several of the larger holdings and found that the bonds are callable early. For example one large holding is:

CUSIP 592646T52
Matures 10/1/2039
Callable at 10/1/20 @ 100
Currently Valued at 113.9
5.0% coupon

I would not attempt to judge whether this bond will be called in 2020 or not. If it is called, the fund will obviously lose the extra 19 years of a 5% yielding bond.

I do not know if Morningstar does this kind of analysis or not when they review a bond fund. I thought they mostly went off of past performance. Let me hypothesize two different funds

a) Muni fund A currently yields 4%, has a duration of 7 years and contains only bonds that are NOT callable. Credit quality = XYZ

b) Muni fund B currently yields 4%, has a duration of 7 years and contains only that ARE callable. Credit quality= XYZ

Even though the statistics are nominally the same, you would expect these two funds to perform differently due to the call/sink provisions. The reason for the difference is that duration changes as interest rate changes. A third factor called “convexity” is used to quantify this. If interest rates continue to fall, you would want to own fund A. It will perform better over the long term. If interest rates rise, fund B would likely perform better.

With enough time, you could be a model of how each fund would perform under different interest rate scenarios. Clearly beyond the scope of most of us.