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Build America Bonds Still Attractive

NEW YORK ( TheStreet) - In the volatile markets of recent months, Build America Bonds have soared.

Representing a small corner of the municipal market, the bonds deliver rich income. During the past year, the Eaton Vance Build America Bond (EBABX), a mutual fund, returned 18%, outdoing 99% of bond funds and topping the Barclays Capital Aggregate Bond index by 12 percentage points, according to Morningstar. PowerShares Build America Bond (BAB), an ETF, returned 17.1%.

Now that the bonds have enjoyed a steep rally, they no longer represent screaming bargains. But the funds are still worth considering for their fat yields. At a time when 10-year Treasuries yield a paltry 2.06%, many Build America Funds yield more than 5% -- a nice payout for a high-quality investment.

The bonds were introduced in 2009 as part of the American Recovery and Reinvestment Act, which aimed to help the economy rebound from the financial crisis. While most municipal bonds are tax-free, Build America Bonds are fully taxable.

Under the program, the Treasury subsidizes 35% of a municipality's cost of making interest payments on bonds. The aim is to help local and state governments pay for capital projects. Municipalities issued $181 billion worth of the bonds in 2009 and 2010. Since then no more of the bonds have been issued. The Obama administration has sought to continue the program, but Republicans in Congress have balked.

Investors have embraced the taxable municipals partly because most Build America Bonds carry top ratings of AA and AAA. Many of the issues are general obligation bonds, which are backed by the full taxing power of municipalities. Other safe issues include bonds that are backed by revenues from essential services, such as water and sewer projects. Many of the Build America Bonds have long maturities of 30 years.

Unnerved by debt problems in Europe and the U.S., investors have fled to the safety of Treasuries and other high-quality bonds, including Build America Bonds. That has pushed up prices of high-quality bonds and lowered their yields. Prices of 30-year securities have done particularly well because long bonds tend to enjoy the strongest gains during periods when rates fall.

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