NEW YORK ( TheStreet ) -- With the Federal Reserve keeping a lid on interest rates, 10-year Treasuries yield a skimpy 1.75%. For a better payout, consider high-yield municipal funds.According to Morningstar, the average fund in the category yields 4.2% tax-free. That is the equivalent of a taxable bond that yields more than 7% for high-income investors.
During the turmoil of 2008, high-yield municipals suffered painful losses. Since then the funds have been rallying as investors have grown more willing to take risks in search of higher yields. In recent months, municipals received a boost from the changes in tax rates. With the expiration of the Bush tax cuts, the top bracket rose from 35% to 39.6%. That made the tax shelter of municipals more valuable and boosted demand for the bonds. During the past year, high-yield municipal funds returned 10.4%, compared to 3.9% for the Barclays Capital U.S. Aggregate bond index. Among the top-performing high-yield funds is Ivy Municipal High Income (IYIAX). During the past five years, the fund returned 8.1% annually, compared to 5.7% for the average peer. In the turmoil of 2008, Ivy lost 18.1%. That was a miserable result, but it outpaced peers by eight percentage points. Portfolio manager Michael Walls limited losses by taking a defensive stance. Walls became cautious as early as 2006, a time when municipal markets were climbing. "We thought municipals were getting hot, and prices were rich," he says.