(PUB) Morningstar FundInvestor

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Municipal Funds on the Conservative Side Tracking Morningstar Analyst Ratings | Russel Kinnel

fund. Low costs and skilled management have led this fund to outgun its peers since we made it a pick in 2002 . Jamie Pagliocco is focused on downside protec- tion, as is apparent from the fund’s top-quartile returns this year and in 2008 . Fidelity aims to have better technology for modeling risks in a bond as well as an entire portfolio, and that’s helped its muni funds to perform well. Silver-rated Vanguard High-Yield Tax-Exempt VWAHX is so cautious on credit risk that it doesn’t qualify for our muni high-yield category. So, its credit risk sits somewhere between the typical high-yield and national-intermediate category. With Vanguard’s low costs, you still get a decent yield. The fund’s 4 . 1% loss this year looks pedestrian compared with its intermediate peers, but that’s still much better than 99% of the muni high-yield group. It’s a good option if you want to trade a little risk for more yield, but only a little. If you want to get really cautious, consider short or intermediate muni funds. These will pack less interest-rate risk, though you lose some yield in exchange. Vanguard Limited-Term Tax-Exempt VMLTX is only a small step from a money market fund, but it’s an important step. The fund has a high-quality port- folio with a 2 . 4 -year duration. Its low 0 . 20% expense ratio ensures you get most of the small yield gen- erated by the portfolio. However, that duration does mean the fund can lose a small amount. In fact, it is down 0 . 70% for the year to date. So, you get a little risk for that added return, but it’s still useful for a lot of people. Vanguard Short-Term Tax-Exempt VWSTX is even closer to a money market with its 1 . 2 -year duration. The fund is up 0 . 02% for the year as its more-modest interest-rate risk has protected it from losses. The fund’s SEC yield is just 0 . 41% , so you can use this as a place to invest money you expect to spend in a year or two or for your emergency-spending kitty. œ

Uh oh. Municipal bonds are the whipping boys again. Meredith Whitney is back on TV pronouncing doom, investors are redeeming muni funds, and the muni market is down 3% – 10% depending on the category. The reason is Detroit’s bankruptcy filing. It’s gotten a lot of attention, but in the muni world, the reaction has been more of a shrug. Muni managers saw this coming a long way off, and odds are that your muni fund doesn’t have any exposure to Detroit. More muni issuers are under strain, but a growing economy makes a wave of defaults unlikely. The last time Whitney predicted doom, the market sold off, and fund investors redeemed their funds. Only, her prediction was off by roughly 50 times. When Armageddon didn’t visit munis, the market rallied sharply. With hindsight, that was a great buying opportunity. Is it possible that we’re coming up on another one? So far the sell-off hasn’t been as dramatic, but muni yields are trading well above Treasuries, whereas historically they’ve traded at lower yields because of their tax benefits. T. Rowe Price Tax-Free High Yield PRFHX has outlegged its peers by a decent margin since we made it a pick in 2005 . We rate it Gold today because we like manager Jim Murphy’s cautious stance in a high-risk space. T. Rowe has the analyst breadth to do thorough analysis on each of its holdings. That’s crucial for a high-yield muni fund, as you really have to tread carefully. The fund is down 6 . 4% for the year to date, which is better than most of its peers. Fidelity Municipal Income FHIGX has less credit risk than the T. Rowe fund, but it does have interest- rate risk as you’d expect from any muni-national long

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Our ratings are chosen for long- term success. Analysts assess a fund’s competitive advantages by analyzing people, process, parent, performance, and price. They do rigorous analysis and then submit their ratings to a committee that vets their work for thoroughness and consistency.