(10/24/14) Fund Trio for High Yield Munis

An improving economy, higher tax receipts, and a shrinking supply of new municipal debt should continue to support prices in the municipal bond market, especially the high yield sector, even if interest rates tick up a bit, explains Mark Salzinger, editor No-Load Fund Investor.

The universe of no-load funds includes only a few funds devoted to high-yield municipals. Two are offered by T. Rowe Price, the first being Tax-Free High Yield (PRFHX), which offers a current SEC yield of 3.4%.

Aided by a 12.2% total return through the first three quarters of 2014, this fund has produced an annualized total return of 7.5% over the past three years and 5.2% over the past ten.

Compared to the high-yield municipal market as a whole, Tax-Free High Yield is actually on the conservative side. In fact, the majority of the bonds (recently 58%) are focused on the two lowest ratings (A and BBB) within the investment-grade universe, while another 7% are rated even higher.

Its lead portfolio manager, Jim Murphy, has been in charge since 2002 and is assisted by eight municipal credit analysts. The portfolio also has a fairly long weighted average maturity (20.72 years as of September 30), which has helped its performance so far this year. Risk is spread widely, with 575 holdings and the expense ratio is a reasonable 0.68%.

Murphy also manages Intermediate Tax-Free High Yield (PRIHX), which Price launched in July 2014. This fund is managed similarly to Tax-Free High Yield.

The main difference is that it should exhibit less sensitivity to changes in interest rates as its maximum weighted average maturity is ten years. This also means that its yield is likely to be somewhat lower than that of its sibling, however.

Vanguard also offers an ostensible high-yield municipal bond fund: High-Yield Tax Exempt (VWAHX). While this fund includes some bonds rated below BBB, 76% of the assets as of the end of August were in bonds rated “A” or better. Only about 10% were in bonds rated as below investment grade or unrated.

Interest rate risk is about average for the high-yield municipal bond category. The weighted average maturity of the holdings was recently 16.0 years.

The fund has gained 5.8% annually over the past three years and 4.9% a year over the past ten. Though these returns are lower than those of the senior Price offering for the same periods, volatility has been lower too, on the order of 25% less.

The Vanguard fund has been managed since 2010 by Mathew Kiselak. Assisted by 15 credit analysts and five traders, he divides the assets among more than 1,000 bonds, recently favoring those from the transportation and health sectors. The fund benefits from an extremely low expense ratio of 0.20% and currently offers an SEC yield of 2.9%.

Investors in the highest tax brackets should consider each of the three funds mentioned if they desire tax-free income.

Those who can stomach the potential for considerable volatility in the pursuit of higher income should favor Price Tax-Free High Yield. Those who are more conservative should favor the other two.