The Growing Magnetism of Munis

But to whom do munis appeal? Individuals are the single largest direct holders of the roughly $2.7 trillion in munis outstanding, holding $960 billion at the end of 2008, up $48 billion from the prior quarter.

Individuals have additional exposure through mutual funds and money market mutual funds, which held $495 billion and $389 billion, respectively, at the end of the fourth quarter. Insurance companies represent the second largest group of holders, at $369 billion. Commercial banks held $216 billion.

Municipal bonds have gained magnetism in recent months, although not enough to bring yields anywhere close to their historic norms relative to Treasuries. Several factors are likely to lead to increased ownership rates for municipal bonds in the short term and in the years ahead:

1. As I've shown, yields in the present time are attractive from an historical perspective. In the case of California bonds, yields are also in the vicinity of the historical return achieved by investing in the stock market.

2. Tax rates are rising and are likely to stay up for a time because of budgetary challenges at every level of government.

3. The bursting of the financial bubble in 2000 and the financial crisis of 2007-09 has shattered the appeal of equities to large numbers of investors, who will be seeking safer investments such as bonds. Investors want to be higher on the capital structure.

4. The U.S. population is aging and investors tend to shift more of their money toward bonds as they age.

Investors that move toward municipal bonds must be selective in the current environment, which factors general obligation bonds over revenue bonds, although certain essential-purpose bonds -- such as those backed by water and sewer revenues -- are relatively safe. General obligation bonds are more secure because municipalities that issue these securities can raise taxes and fees to cover their obligations.

Less safe bonds are based on revenue that can be volatile or subject to impairment because of conditions in the economy or in a specific industry. A standout in this regard is the market for hospital bonds, where the ability to repay debt has been eroded by losses that hospitals have had to incur because of the economic contraction. Credit analysis is therefore crucial in the current environment.

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Know what you own: A number of bond-related ETFs might be of interest to readers of this column, including the SPDR Barclays Short-Term Municipal Bond ETF (SHM - commentary - Cramer's Take), the SPDR Barclays Municipal Bond (TFI - commentary - Cramer's Take) ETF, the iShares Barclays 20+ Year Treasury Bond (TLT - commentary - Cramer's Take) ETF, the iShares Barclays 7-10 Year Treasury Bond (IEF - commentary - Cramer's Take) ETF, the iShares Barclays 1-3 Year Treasury Bond (SHY - commentary - Cramer's Take) ETF, the iShares Barclays 3-7 Year Treasury Bond (IEI - commentary - Cramer's Take) ETF and the iShares Barclays 10-20 Year Treasury Bond (TLH - commentary - Cramer's Take) ETF. For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.

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Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of the revised investment classic, The Money Market, first published in 1978 by Marcia Stigum, and The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.

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