Municipal bonds: an investment with civic pride

With stock markets swinging wildly and credit markets trying to claw their way out of an icy freeze, investors have been searching for stability anywhere they can find it.

But the quest for financial security does not mean investors have to jettison moral values or bypass opportunities to make a difference. Instead, money managers and observers say, they can earn steady returns – and supply much-needed cash for public services – by investing in municipal bonds.

Muni-bond yields have reached historic highs this fall relative to US Treasury Bonds, which traditionally pay higher interest rates than munis. Since jittery investors have been shy to step up, yields on new muni issues have recently climbed to pay as much as 50 percent more than Treasury bonds.

As a result, investors have been finding high-quality, long-term bonds rated "A" or higher that pay a handsome 6 percent and more in tax-exempt income.

"If you look from a historical perspective at what tax-free bonds are yielding right now, it's a great time for individual investors to be starting to look at individual bonds," says Monte Avery, who manages seven state-specific, municipal bond funds for Integrity Mutual Funds of Minot, N.D.

For investors eager to address civic needs through their investments, munis hold a particular appeal. States and localities depend on the $2.66 trillion muni market to finance everything from bridge repair to school construction and water-system upgrades.

"Municipal bonds allow individuals to get involved in their local communities to help build a school, a hospital, or some infrastructure … so there is a strong social component," says Paul Sutherland, a Traverse City, Mich., money manager for individuals and for Utopia Mutual Funds, which seek out "sustainable" investments. "Plus, a lot of people prefer municipal bonds over US government bonds because US bonds fund a lot of things that people don't want to support, such as war and activities that people might consider exploitative in other countries."

Now, with a nasty recession seeming to loom large, state and local government needs for investment capital are becoming especially acute. This month, investors helped avert a California government shutdown by buying up nearly $4 billion in "revenue anticipation" bonds over a 48-hour period. Also this month, individual investors snatched up most of a $550 million bond issue from New York City, which has recently tiptoed back into a previously frozen municipal bond market. Other cities, shaken by recent events, hope there's more cash where that came from.

Earlier this fall, "there was nobody willing to make a loan anymore on a short-term basis," says Chris Hoene, director of policy and research for the National League of Cities. "The big problem here [for many cities] is that the money is just not flowing."

If heartened by California's and New York City's successful offerings, more states and cities will be apt to issue short-term bonds as they cope with shrinking revenue streams, according to Kim Reuben, a public finance economist with the Urban Institute, a policy think tank in Washington, D.C. That could mean new opportunities for investors to help out in times of extraordinary need – and perhaps give their portfolios an overdue boost in the process. An investor who buys a muni through his or her home state usually receives an investment that's exempt from state as well as federal tax.

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