WASHINGTON -- Municipal bond funds are making a comeback as individual buyers, disgruntled with money-market returns that barely compete with passboook accounts, look for strong, tax-sheltered income.
According to money managers and industry statistical reports, the rising demand from investors is a direct result of falling money-market fund rates, while municipal bond fund yields have not come down nearly as much.
"Money clearly came out of short funds into long funds," said Jacob Dreyer, vice president and chief economist at the Investment Company Institute. "People generally traded up the yield curve."
The average yield on taxable money-market funds since early January has tumbled to 5.51% as of June 4, from 7.09%, a decline of more than 10 basis points, according to IBC/Donoghue's Money Fund Report. A year ago, yields were 7.67%. Yields on municipal bonds, meanwhile, have fared far better. The average yield on The Bond Buyer's 20-bond index was 7.06% last week, a comparatively small decline from 7.21% a year earlier.
Other factors contributing to the influx of money include aggressive marketing by fund managers, increasingly sophisticated investors -- who are trying to protect their income from rising state taxes -- and perhaps a swelling of the Baby Boomer ranks.
"To get tax-exempt income, there is no other game in town other than tax-exempt bond funds, and bond funds provide a convenient vehicle," Mr. Dreyer said.
"Our municipal fund is growing very fast," said Richard Ciccarone, director of fixed-income research for Kemper Securities Group Inc. in Chicago.
According to the Investment Company Institute, the trade association for the mutual fund industry, money has been pouring into municipal bond funds of all types in recent months. Through April, net sales of long-term municipal bond funds totaled $5.41 billion, up 34.2% from the $4.03 billion during the same period last year. Sales of single-state municipal bonds surged to $3.11 billion from $2.37 billion, an increase of 31.3%.
In fact, single-state municipal bond funds have proliferated rapidly. According to Lipper Analytical Services Inc., the number of single-state funds reached 345 in May, compared with 285 a year earlier.
The Investment Company Institute reported sales of other types of bond funds also advanced, led by a jump to $4.70 billion in global bond funds, from $663.9 million last year. Junk bond sales were the one exception, falling to $1.87 billion from $2 billion.
In April alone, net sales of bond and other fixed-income funds reached $6.3 billion, compared with $4.4 billion in March and $1.9 billion in April 1990. And new money fueled the bulk of the bond purchases, Mr. Dreyer said.
Brian Mattas, vice president of the Vanguard Group of Investment Companies in Valley Forge, Pa., said net cash flow into mutual bond funds operated by the firm totaled $566 million through April, more than double the $213 million in the same period last year. Money coming into intermediate-term municipal bond funds more than tripled while investments in money-market funds fell off sharply, Mr. Mattas said.
Municipal bond funds also have been more than holding their own against mutual stock funds and other forms of investment in the last several years, according to Investment Company Institute figures. While investment activity generally stalled temporarily after the stock market crash of 1987, growth resumed in the following years and continued right up to the present.
Assets of long-term municipal bond funds increased to $72.3 billion in January 1991, from $51.5 billion in January 1988. State long-term municipal bond funds have soared from $29.2 billion to $50.6 billion.
Short-term municipal bond funds also have been growing. Assets of municipal funds increased from $59.8 billion in January 1988, to nearly $64 billion. State funds rocketed from $7.9 billion to $25.4 billion, a more than threefold increase.
"We think the outlook for the market is good because you're going to see strong demand for high-quality municipal bonds, and that will certainly be favorable for the industry," said Steven Norwitz, vice president of T. Rowe Price Associates Inc.
Mr. Norwitz said he is optimistic about demand for municipal bonds because he expects states and localities to keep raising taxes, leading more and more people to look for tax-exempt income. That view seems to be borne out in the sharp rise in single-state bond funds, which shield investors who live in the states where they are offered from both federal and state taxes.
For example, in New Jersey an individual in the top federal tax bracket of 31% who must pay an additional 6.5% income tax to the state has a combined marginal rate of 35.5%, Mr. Norwitz said. For such investors, a 6% yield on municipal bonds translates into a 9.3% taxable yield -- not bad by most market standards today.
T. Rowe Price recently began marketing no-load, single-state municipal bond funds in Virginia and New Jersey. They are also offered in Maryland, California, and New York -- all industrial states with high tax levels and many high-income investors.
There is plenty of evidence to support the view that state tax burdens will be rising -- a function of the continuing shrinkage of federal payments, the recession, and increasing state demands to fund Medicaid and other needs. The National Conference of State Legislatures estimates the 21 states face budget deficits totaling some $35 billion in the next fiscal year, about $15 billion of which will be met through tax increases.
"There is a lot of activity in top-bracket personal income tax rates in large states, and it isn't over yet," said Hall Hovey, publisher and editor of State Budget and Tax News in Alexandria, Va. "And there are lots of other smaller states where increases could take place."
This year alone, states will raise taxes some $17 billion, the biggest annual increase ever and roughly equal to about $100 for every U.S. worker, Mr. Hovey estimates.
Some analysts predict bond funds will get a boost as the aging Baby Boomers step up savings during the 1990s in planning for education and retirement expenses. These are the people born between 1946 and 1964, and they are now moving in large numbers into their peak earning years.
The Census Bureau projects that the number of people aged 35 to 44 will rise from 36.6 million in 1989 to 43.9 million by the year 2000. The number of people aged 45 to 54 is projected to swell from 24.9 million to 37.2 million, an increase of nearly 50%.
A study conducted by the Conference Board and the Census Bureau in 1987 showed that discretionary household income tends to rise with age, said Arnold Goldstein, a demographic statistician for the Census Bureau. The study found that discretionary income in households headed by people aged 35 to 39 was $12,405 in 1986 and rose to $14,448 in households with people aged 35 to 49.
But not everyone is convinced the aging Baby Boomers will transform themselves from conspicuous consumers to cautious savers who invest in municipal bonds. The Commerce Department reported that in April the personal savings rate, or the share of personal income set aside for savings, was scraping bottom at 3.7%, the lowest rate since October 1987.
A staff study prepared for the Federal Reserve Board in May estimated that the increase in people 45 to 64 will boost the U.S. saving rate by only a quarter to a half of a percentage point by the year 2010. While there will clearly be lot of aging Baby Boomers, there is little evidence to show that middle-age people have a higher savings rate than other groups of people, the study concluded.
A growing population will tend to boost savings, but U.S. population is only growing at about 2% a year, said Arthur Kennickell, author of the Fed report.
