Investors found some of their best performers in the most unlikely corners of the market this year.
The municipal bond market has been one of those places. Most mutual funds that specialize in muni bonds have generated a total return of a bit more than 10 percent so far this year, about double their long-term average and far better than the 5.9 percent earned by the stocks in the Dow Jones industrial average.
I dove into that municipal bond market in search of a good candidate for the 2011 Boston Capital mutual fund manager of the year.
In particular, I went out of my way looking for managers who run funds specializing in Massachusetts municipal investments.
This year’s selection: Thalia Meehan, manager of the Putnam Massachusetts Tax Exempt Income Fund. She is the 11th local fund manager to earn this annual Boston Capital honor, joining a list of past winners that includes Will Danoff, Joel Tillinghast, Dan Fuss, and Ken Heebner, among others.
Meehan is a self-described “muni geek through-and-through’’ who joined Putnam’s tax-exempt bond group 22 years ago and currently serves as its managing director. Her Massachusetts municipal bond fund had earned 10.9 percent for 2011, through Wednesday, performance that ranks the fund in the top quarter of its class, according to Morningstar.
The 2011 performances of Massachusetts municipal bond funds—in fact most muni bond funds—tend to be tightly clustered, with small differences separating individual funds. Add other performance measures, such as three- and five-year returns, to the mix and the pack still remains very competitive.
There were other muni funds and managers who looked attractive from some perspectives. Eaton Vance’s Massachusetts municipal bond fund has out-gained the pack this year, but it tends to fare the worst by far in difficult markets. It got crushed in 2008.
The Fidelity Massachusetts Municipal Income Fund has performed well over many different time periods, but the Boston Capital award is about managers, not funds. Manager Kevin Ramundo took over Fidelity’s Massachusetts muni fund less than two years ago.
I selected Meehan because her Massachusetts fund has made the most of good times in the muni bond market and protected shareholders reasonably well through tougher periods. Her $311 million Massachusetts muni portfolio has produced an average annual return of 9.7 percent over the past three years—a relatively sunny stretch for the muni market after a disastrous 2008 market. The Putnam Massachusetts muni fund lost 6 percent that year.
Like other muni investors, Meehan benefited greatly this year from a reckoning that never happened. Municipal bonds and funds that own them got clobbered in the final months of 2010 when high-profile doomsayers predicted massive credit defaults on the horizon. The basic idea: Local governments would not be able to cope with a bad economy and huge budget problems.
So municipal bond funds started the year with depressed prices, and worried investors waited to see what would happen.
“It was a fairly painful period in the muni bond market,’’ says Meehan. “It was like yelling fire in a crowded theater.’’
But massive defaults did not occur and muni bond prices began to recover. As the market gained steam, muni funds saw the value of their bonds appreciate, adding substantially to total returns.
“To be fair, there had been some underlying issues about state budget gaps and pension funding issues,’’ says Meehan. “Those were real but conclusions about what might happen as a result were way overdone. While there have been some well-covered defaults in the muni market, they have been fairly isolated and certainly not systemic.’’
Municipal bond fund managers like Meehan all make decisions about broad investment themes as they shape portfolios. What levels of risk—based on credit ratings—do they want to own? Should they own more longer-term bonds that can maximize gains or shorter-term securities that can minimize risk from interest rate movements?
Putnam’s municipal funds don’t make extreme bets on any of those issues. But Meehan has tilted her Massachusetts fund away from city and town general obligation securities in favor of so-called essential service revenue bonds, which finance specific things that generate cash to repay debts.
“These are things like colleges, roads and bridges, and sewer facilities—things that sound hokey but we rely on them every single day,’’ Meehan says.
Beyond the big investment themes, muni funds depend on credit research—one bond at a time. “This is fundamentally a very sound market, but if you pick the wrong credit it can be a very painful experience,’’ she says.Continued...