These Mutual Funds May Keep Rallying

Strickland says the shakier bonds are cheap because of unwarranted fears of defaults. "Municipal credit quality will hold up better than many people think," he says.

According to Standard & Poor's, the default rates of investment-grade municipals have been tiny. During an average 10-year period, only 0.13% of investment-grade municipals defaulted. With the economy in recession, the default rate could climb to 1%, Strickland concedes. But he says bonds are currently being priced to account for a 20% default rate. As long as defaults stay below that level, municipals will likely deliver healthy returns.

To take advantage of discounts on lower-quality bonds, Strickland recently opened Thornburg Strategic Municipal Income Fund(TSSAX Quote). The fund can buy bonds of all credit qualities, including those rated below investment grade. "This is a time when it pays to take some thoughtful risk," Strickland says.

Investors who have no stomach for risk should consider Thornburg Limited-Term Municipal(LTMFX Quote), which has an average credit quality of AA. Another cautious way to bet on a revival of the municipal market is Fidelity Intermediate Term Municipal(FLTMX Quote), which has an average credit quality of A.

Besides worrying about the weakening financial condition of municipalities, investors have been troubled by concerns about municipal bond insurance. When Ambac and other bond insurers faced problems last year, the value of insured bonds collapsed. That hurt returns of many funds. But now the threat of defaults by bond insurers has been neutralized.

Some funds have simply begun to avoid insured bonds. After losing 5.8% in 2008, Franklin Massachusetts Insured Tax Free Income(FMISX Quote) decided to take "insured" out of its name and drop the requirement that the fund had to invest 80% of its assets in insured bonds.