Tales from the Darkside of Bonds – Santa Fe, NM Munis

by JR Robinson on October 3, 2013

Over the past year, I have made no secret of my concern that many investors do not fully appreciate the riskiness (i.e., price volatility) of traditionally staid and conservative fixed income investments, such as municipal bonds and U.S. treasury securities.  Perhaps a recent real life example will help drive the point home.

Last month, a long-time friend and client asked me to take a look at a recently issued Santa Fe, New Mexico bond he had been offered.  Using EMMA® (the Muncipal Securities Regulatory Board’s public online research tool), I quickly discovered that the 13 year bond  he had been shown had just been issued in June at an initial offering price of around 98 ($980 per bond) with a yield to maturity of around 3%.  “What’s the big deal,” I said, unenthusiastically.  “Do you really want to lock in 3% [albeit exempt from federal income tax] for 13 years at a time when rates have just started to rise off their all-time lows?”  His response nearly made me fall out of my chair – “No, I wouldn’t,” he said, “except that the bonds are now being offered in the secondary market at 87 ($870/bond).”

98 to 87 in less than two months! Mind you, we are not talking about the volatility one would expect from a municipality, such as Stockton, CA or Detroit, that is teetering on the verge of bankruptcy.  Santa Fe’s Aa3 bond rating is roughly on par with that of the U.S. Government!…And yet the bond lost approximately 15% of its value less than two months after it was first issued.  Such volatility might be considered higher than average even for a blue chip stock.  For a highly rated, intermediate term municipal bond, such a big decline at just the first hint of rising interest rates should send alarm bells out to investors who are considering reaching for yield in the bond market.

Note:  FPH clients who still own bond funds, especially preferred stock funds and leveraged ETFs, should seriously reconsider whether the above average current distribution yields remain commensurate with the market volatility.

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