NEW YORK (TheStreet) -- Beyond the headlines about credit troubles in Puerto Rico and Chicago, there is a lot to like about the municipal-bond market, said David Dowden, portfolio manager for the MainStay Tax Free Bond Fund.
"The market certainly has not behaved as we anticipated in the beginning of the year," Dowden said. "On the other hand, when we look at the overall market and where it is heading from here, we are pretty optimistic about relative performance."
Dowden's bond fund, which sports a 3.7% yield, is flat year to date and is up 4.4% over the past 12 months, according to fund tracker Morningstar. The fund has outperformed 87% of its peers, according to Morningstar, primarily because it has avoided a number of landmines in the minimarket such as New Jersey paper.
"If you look at New Jersey, it is the worst performing state in the market today on an overall credit basis, and that is a name that we have migrated away from in the last year and a half," Dowden said.
"Illinois is a credit that we avoided a long time ago. Our argument has been that while general credit fundamentals are improving, overall there are winners and losers, and it is our job to discern among those," he said.
Issuance is another driver of muni-bond performance, and that has been strong this year, as well. Dowden said the market is on pace to go over $400 billion, largely driven by refundings. He added that the number of insured bonds has increased, as well, which he views as positive for the market.
"Insurance was written off for a number of years," Dowden said. "People felt that the insurers were in trouble, and they could not be counted on, but they have considerable capital. We've seen a resurgence this year. Year to date, we are at about 7.4% on new issuance; over the last few years we have been below 5%, and we believe we can still get to just under 10% of all new issuance this year."
Munis remain cheap relative to Treasuries in Dowden's view. Nevertheless, he said investors need to be on the right part of the yield curve to maximize this discount.
"As you migrate out the curve and go beyond 10 years, the ratios go above 100% of Treasuries," Dowden said. "You are earning on a nominal basis more yield than you can earn on a taxable Treasury bond. We consider that part of the curve to still be very attractive."
Finally, Dowden said he is a fan of tobacco bonds, saying he can barely think of another part of the muni market where investors can get similar yields without taking undue credit risks.
"Tobacco bonds are what we would refer to as a 'dollar-price game,' " Dowden said. "It's all a function of understanding the timing of the cash flows and how long it is going to take to get paid back. As investors are losing bonds in this market due to redemptions and maturities, they are looking for a replacement for that yield, and tobacco is their solution."