January 2009

While the global credit crisis left all asset classes in its wake in 2008, the municipal bond market may now offer attractive investment opportunities.

“We labored through a tough year,” said Northern Tax-Exempt Fund Manager Timothy McGregor. “Tax-free bonds were hurt by some extremely unusual circumstances.”

That’s a polite way of saying that the global credit crisis inflicted collateral damage on the usually staid market for tax-exempt bonds. Though the factors are many and complex, they boil down to this: The secondary sources of supply for municipal bonds overwhelmed demand for most of the year.

Sentiment also played a role.

“Borrowers couldn’t get funding, and lenders became risk averse,” McGregor says. “That’s a bad combination.”

Better tomorrows
Of course, bad combinations can be fertile ground for opportunity.

Already, some of the factors that upset the normal balance of supply and demand in the municipal marketplace are dissipating, creating some compelling opportunities.

Yet, McGregor remains cautious.

He’s especially wary of revenue bonds linked to cyclical areas of the economy and bonds that lack generous debt- coverage ratios.

But that still leaves plenty of high-quality bonds backed by the unlimited taxing power of the municipality. Yields on those general obligation bonds are virtually unprecedented compared to their taxable equivalents.

In fact, some AAA-rated municipal bonds now yield significantly more after taxes than Treasuries do before taxes.

“You don’t even need to be in a high tax bracket to come out ahead in municipals,” McGregor says. “The math is very compelling.”

Emphasis on quality
McGregor’s fund focuses on credit quality.

“We work hard to understand the creditworthiness of each borrower,” he says. “Safety has always been our top priority, and that’s not going to change.” The Fund holds nearly 200 bonds, most of which are rated AA or better.

Though he’s not likely to soon forget the market’s recent travails, McGregor thinks municipal bonds may be poised for a strong rally.

“Some of the problems are behind us,” he says. “I believe municipal bonds offer significant value.”

Disclosure
Bond funds will tend to experience smaller fluctuations in value than stock funds. However, investors in any bond fund should anticipate fluctuations in price, especially for longer-term issues and in environments of rising interest rates. The fund’s income may be subject to certain state and local taxes and, depending upon your tax status, the federal alternative minimum tax.