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If there's one constant in the investment world, it's that investors crave yield.
With the U.S. Federal Reserve now determined to keep interest rates at record lows in the hope of stimulating stronger economic growth, the hunger for yield has been harder to satisfy: the yield on the benchmark 10-year U.S. Treasury note dipped below 2.5% as recently as September 2010, and it hasn't topped 5% since July 2007.
Normally, yield-hungry investors are not big buyers of municipal bonds. Muni bonds usually trade at an even lower yield than comparable Treasury bonds, because their interest payments are not subject to federal – and sometimes state – income taxes.
In recent weeks, though, concerns about a possible spike in defaults among muni issuers have pushed the yields on long-dated muni bonds above Treasuries.
In early January, 30-year muni bonds offered yields equal to 108% of similar Treasury bonds, according to a Bloomberg report.
Yet even yields that are attractive relative to Treasuries may not be enough to entice investors when Treasury yields are so low to begin with.
In that case, it may be time to investigate high-yield muni bonds, which comprise about 10% of the $2.7 trillion muni market.
These bonds are issued by less credit-worthy borrowers such as hospitals, nursing homes, schools and even private developers, so they must offer larger yields to attract buyers.
There are roughly 30 distinct mutual funds that invest in high-yield municipal bonds available to U.S. investors.
Over the past five years, performance among these funds has varied widely: average annual returns have ranged from a high of 3.62% to a loss of about 5%.
Most funds charge an upfront sales load, while annual expense ratios run from 0.55% to 1.84%. Almost all of these funds pay monthly dividends.
To identify the most attractive high-yield muni-bond funds, we screened for funds that are open to new investors, not intended for institutional shareholders and have a high rank from Standard & Poor's methodology. We then chose three that have strong performance records and reasonable costs.
