Municipal Funds Veer From Safety to Danger

To prepare for a rebound, consider Eaton Vance National Municipals(EANAX). The fund's portfolio has an average maturity of 25 years, one of the longest of any fund. In contrast, the average long municipal fund has an average maturity of 15 years.

Portfolio manager Tom Metzold favors long bonds because they yield more than short issues. He typically buys securities rated A or higher by Standard & Poor's, and holds the bonds for years. The strategy worked beautifully from 2002 through 2006 when Eaton Vance outdid 99% of its competitors.

Then, beginning in 2007, trouble appeared as hedge funds and other investors sold municipals to raise cash for margin calls. Much of the selling involved long bonds, and their prices sank. When bond prices fall, yields rise.

Now the yield gap between short and long municipals is unusually wide. According to Bloomberg, the yield on 2-year AAA-rated general obligation municipals is 2.02%, compared to 5.62% for 20-year bonds. By that measure, long bonds are extremely cheap, says Metzold. "When the markets return to normal, long bonds should outperform," he says.

If long bonds climb, another choice that should outdo peers is Thornburg Intermediate Municipal(THIMX). The fund's portfolio has a maturity of 8.4 years, almost the same as the average intermediate municipal fund. But Thornburg follows a distinctive approach.

While most intermediate funds focus on bonds with maturities of 5 to 15 years, Thornburg uses a method known as laddering. In a typical ladder, an investor buys bonds with maturities of one year, two years, three years and so on. Thornburg holds maturities up to 18 years. If prices of the long issues climb, the fund will beat competitors that hold only intermediate bonds.