NEW YORK (TheStreet) -- Robert DiMella, co-manager of the MainStay Tax-Free Bond Fund (MTBAX) - Get Report, says rising income taxes should stoke demand for tax-exempt municipal bonds, supporting their prices.

The $246 million MainStay Tax-Free Bond Fund has returned 1.4% this year, outperforming 77% of competing funds, according to

Morningstar

(MORN) - Get Report

. The fund has gained 2.6% annually, on average, during the past five years, trailing its category by 0.3%.

Welcome to

TheStreet

Fund Manager Five Spot, where America's top mutual fund managers share their investment views in five fast and furious questions.

What is your outlook for the economy?

DiMella:

Our team believes that the economy is going to remain in a slow-growth phase, with a

risk of a double dip

. We believe that rising income tax rates at both the local and federal levels, continued budget cuts at the state and local levels will keep the economy from gaining significant momentum and mitigate the federal stimulus job growth in the near future.

What is your favorite bond issue right now?

DiMella:

TST Recommends

Due to the thousands of different municipal issuers and bonds in the marketplace, we don't have a specific bond that's our favorite but, generally speaking, we are overweight revenue-backed bonds. We believe that the headline risk of a weakening economy and the impact on local government's budgets will increase price volatility of general obligation bonds versus essential service revenue bonds.

What type of bonds would you avoid?

DiMella:

Within our MainStay Tax-Free Bond Fund, we are underweight issuers that rely on subsidies from state governments. We believe that these subsidies are at risk as states attempt to balance their budgets. Such issuers come to market with local general obligation bonds, tax-allocation bonds, lease and annual appropriation credits. We are also underweight health care credits in over-bedded hospital markets, like northern New Jersey and Chicago.

In the muni market, what are your favorite and least favorite states?

DiMella:

There are certain states that have fared well in the recent recession. Texas and Washington are two states we are positive on with respect to credit, although finding opportunities is not easy due to tighter spreads.

Investors have to be careful with states that have had higher growth in spending going into the financial crisis. These would include Calif., Ore., Ariz., N.J., Conn., Ill., Nev. and Fla. However, we are seeing attractive opportunities on selected bonds, as investors and money managers make no distinction in avoiding both the strong-stable credits as well as the weaker issuers from those states.

Will we see a lot of new muni bonds hit the market? What will the demand be?

DiMella:

Technically speaking, the municipal market is looking very positive. The Build America Bond program, a part of the American Recovery and Reinvestment Act in 2009, is providing municipal issuers the opportunity to bring their debt to the taxable market. This is causing a sharp decline in new issue supply in fixed-rate tax-exempt bonds, especially securities with maturities greater than 20 years. This imbalance in supply and demand will cause the municipal yield curve to flatten in 2010. This is occurring at a time when income tax rates are increasing, causing greater demand for tax-exempt municipal bonds, which should provide strong price support for tax-exempt municipal bonds.

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Reported by Gregg Greenberg in New York

.

Before joining TheStreet.com, Gregg Greenberg was a writer and segment producer for CNBC's Closing Bell. He previously worked at FleetBoston and Lehman Brothers in their Private Client Services divisions, covering high net-worth individuals and midsize hedge funds. Greenberg attended New York University's School of Business and Economic Reporting. He also has an M.B.A. from Cornell University's Johnson School of Business, and a B.A. in history from Amherst College.