Time to re-think muni's as safety anchor?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.

(For investors in high tax bracket), Is it time to re-think using muni's as safety anchor?

No, I will continue to use muni's
65
47%
No, I will continue to use muni's
65
47%
Yes, I will shift to using treasuries since safetly is more important.
7
5%
 
Total votes: 137

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indexfundfan
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Time to re-think muni's as safety anchor?

Post by indexfundfan » Tue Mar 11, 2008 4:26 pm

For many people, the fixed income or bond portion of the portfolio is designated as the safety anchor of the portfolio during market turbulence (basically Larry's viewpoint, not Rick's).

The recommendation has been to use very high grade and short term debt instruments like treasury bond funds or even VG's invest-grade bond funds. And for investors in high tax brackets, it has been generally recommended to use municipal bond funds.

However, the recent municipal bond turmoil shows that muni's are not working as they should. Just as you hope municipal bonds can help soften the losses on the equity side, it does exactly the opposite, tanking along with equities.

Is it time to re-think the usage of municipal bond funds as part of the safety anchor?

It seems that the fact that the municipal bond market is rather illiquid and often subject to hedge fund's trading activities might make municipal bonds unpredictable during market turmoil.

What do you think?
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Post by allenmickers » Tue Mar 11, 2008 4:51 pm

I dont mean to say munis are worthless because I made $400 on a $10k one week investment last week, but unless your entire tax-sheltered accounts are already filled with treasury grade bonds and you still need more bonds to meet your AA, then I would consider munis.

I would rate munis as between treasury and high investment grade. They are also tax exempt. Therefore if you need more high grade bonds and you need to put them in a taxable account, consider munis.

I personally dont feel comfortable relying on any one thing for a particular part of my AA, so if theres a future liquidity problem with your muni holdings, and you need cash right away, then sell your treasury bonds while you wait for a buyer of the munis.

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Post by Gekko » Tue Mar 11, 2008 4:53 pm

bonds were never meant to replace money markets!

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Post by indexfundfan » Wed Mar 12, 2008 10:23 am

From the poll results, it appears that most don't seem to think much of the "equity-like" risk demonstrated by muni's recently. Interestingly, I suspect many would nevertheless recommend against the Vanguard high yield bond fund for its "equity-like" characteristics.
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Post by sscritic » Wed Mar 12, 2008 11:01 am

Sell low, buy high! Dump your muni-bonds for treasuries!

Does anyone see a problem here?

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Post by indexfundfan » Wed Mar 12, 2008 11:18 am

You can take the poll that way if you wish.

But I am asking a fundamental question about asset allocation -- whether muni's are good enough as a safety anchor.
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Re: Time to re-think muni's as safety anchor?

Post by dbr » Wed Mar 12, 2008 11:22 am

indexfundfan wrote: However, the recent municipal bond turmoil shows that muni's are not working as they should. Just as you hope municipal bonds can help soften the losses on the equity side, it does exactly the opposite, tanking along with equities.
This statement moots a highly premature conclusion. I think most people voting with the muni's are rejecting your premise.

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Re: Time to re-think muni's as safety anchor?

Post by ddb » Wed Mar 12, 2008 11:29 am

Although I understand your question, I don't understand the BASIS for your question. According to the Vanguard page for VWITX, the Intermediate-Term Tax-Exempt Fund, the fund's YTD total return through 2008-03-11 is +0.04%. If a 10-week period of flat performance in an asset class causes you to rethink your asset allocation, then maybe you'd just be better off having everything in a money market!

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Post by indexfundfan » Wed Mar 12, 2008 11:34 am

Actually, I am talking about the period from Feb 22 to Feb 29 where muni's are tanking along with equities because of various factors, part of which were caused by hedge funds.

While this could be seen as a one-time event that does not last long, what would you do if it lasts longer or occur more frequently?

And by the way, I do not have muni bonds in my portfolio.
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Post by Sidney » Wed Mar 12, 2008 11:40 am

From the poll results, it appears that most don't seem to think much of the "equity-like" risk demonstrated by muni's recently.
I thought the recent volatility in munis was due primarily to liquidity issues.

The volatility of equity (mainstream) is something altogether different IMO.
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Post by INDUBITABLY » Wed Mar 12, 2008 12:18 pm

indexfundfan wrote:Actually, I am talking about the period from Feb 22 to Feb 29 where muni's are tanking along with equities because of various factors, part of which were caused by hedge funds.

While this could be seen as a one-time event that does not last long, what would you do if it lasts longer or occur more frequently?

And by the way, I do not have muni bonds in my portfolio.
Treasury bonds of similar maturity have been quite volatile, too, during this "flight to safety" that we have seen since last summer. I'm not sure why an event taking place in the space of a week should be of concern to anyone with a time horizon long enough to justify holding bonds in place of cash.
"Ah ha! Once again, the conservative, sandwich-heavy portfolio pays off for the hungry investor!" - Dr. Zoidberg

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Post by ddb » Wed Mar 12, 2008 12:55 pm

indexfundfan wrote:Actually, I am talking about the period from Feb 22 to Feb 29 where muni's are tanking along with equities because of various factors, part of which were caused by hedge funds.

While this could be seen as a one-time event that does not last long, what would you do if it lasts longer or occur more frequently?
Well, it's one week, so it causes me no concern. Even if we see a 3-year period where munis have high correlation with equities, I wouldn't be concerned.

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Post by indexfundfan » Fri Oct 17, 2008 12:33 am

It seems like this same issue is popping up again.
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Post by stratton » Fri Oct 17, 2008 5:26 am

indexfundfan wrote:It seems like this same issue is popping up again.
Everything is getting it or TIPS wouldn't sharing the down party with the muni bonds.

Paul

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Post by daryll40 » Fri Oct 17, 2008 6:59 am

I started to think that perhaps the market is pricing in inflation as the eventual cost of the bailouts. But your point about TIPS getting hit, which I also noticed, kinda shoots down that theory.

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Post by larryswedroe » Fri Oct 17, 2008 7:21 am

what we are seeing is a liquidity crisis which will come to an end once the deleveraging comes to an end.
Even in the Great Depression AAA munis held up well, and this will not be anywhere near that situation when 35% of industrial production evaporated and 25% unemployment was hit

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Post by Kenkat » Fri Oct 17, 2008 7:37 am

The truth is, sometimes everything goes down (except cash). Treasury bonds are not exempt from that either.

I own IT Muni and it is down around 5.5%. I also own High Yield Corp and it is down 20% or something like that. Oh well. My reasoning for holding them hasn't really changed.

Ken

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Post by Gekko » Fri Oct 17, 2008 7:57 am

i think the lesson learned for some of us is this -

if you hold a muni bond fund, be prepared for the possibility of a significant NAV fluctuation down that may last for a relatively long time. bonds are not cash, and if you may need to withdraw the money within a short time horizon (~5 years) or can't stomach it, bonds may not be a good fit for that bucket of your money. stick with cash instead.

personally, i expected some NAV volatility, but nothing like this.

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Post by larryswedroe » Fri Oct 17, 2008 8:13 am

Gekko
The lesson for those that did not already know it is to EXPECT the unexpected and build that into your plans to the extent possible--without avoiding all risks which dooms you to tbill returns. In effect, the Black Swans. We do know they will show up, just not when and in what form. That is why it is critical to not take more risk than one has the ability, willingness or need to take---and to not treat the unlikely as impossible---and to remember that just because something has not happened YET does not mean it cannot or will not happen.

Those are among the most important lessons I learned long ago as a manager of risk. And they are the lessons I have tried to teach here.

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Post by Gekko » Fri Oct 17, 2008 8:37 am

larryswedroe wrote:Gekko
The lesson for those that did not already know it is to EXPECT the unexpected and build that into your plans to the extent possible--without avoiding all risks which dooms you to tbill returns. In effect, the Black Swans. We do know they will show up, just not when and in what form. That is why it is critical to not take more risk than one has the ability, willingness or need to take---and to not treat the unlikely as impossible---and to remember that just because something has not happened YET does not mean it cannot or will not happen.

Those are among the most important lessons I learned long ago as a manager of risk. And they are the lessons I have tried to teach here.
agreed, but these are bond funds we are talking about here. the bonds were supposed to mitigate risk!

best wishes.

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Post by daryll40 » Fri Oct 17, 2008 8:43 am

Don't forget to add the coupon (interest payment) to your return. Year to date returns posted on the web site do not consider that.

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Post by newport1 » Fri Oct 17, 2008 8:43 am

What is crazy is that CA munis are yielding more on a taxable equivalent basis than similar maturity investment-grade corporates. I find it hard to believe that the default rate on CA bonds is likely to exceed that of high-grade corporates.

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Post by Gekko » Fri Oct 17, 2008 9:09 am

daryll40 wrote:Don't forget to add the coupon (interest payment) to your return. Year to date returns posted on the web site do not consider that.
VG muni bond funds? are you sure?

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Post by Gregory » Fri Oct 17, 2008 9:11 am

Some of the wisest investing advice I ever received about muni bonds was from a retired CPA who told me that when he purchased his [individual] bonds he did not pay attention to anything except the coupon. That's how I view the individual bonds (zero-coupon muni's) and bond funds (VWIUX, VG TIPS fund, etc.) I hold.

I suppose the market price for most muni bonds bill fluctuate to some degree, even the individual ones we hold -- but if you don't plan on selling, only collecting the coupon, then it's not as much a concern.

Gerg

(Edited for syntax)
Last edited by Gregory on Fri Oct 17, 2008 1:53 pm, edited 1 time in total.
Pecuniae imperare oportet, non servire. | Fortuna vitrea est; tum cum splendit frangitur. -Syrus

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Post by daryll40 » Fri Oct 17, 2008 9:15 am

Kinda sorta right. It's true that your coupon goes up as prices fall.

It's sort of like owning a home and living there for 30 years. The value may go up and (like now) it may even fall. You don't care because you don't plan to move. But the value is still the value and it may, indeed, be less or more.

Sort of like the old "it's only a paper loss" argument. Yeah, paper loss but CONVERTIBLE into less REAL STUFF!

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Post by snowman9000 » Fri Oct 17, 2008 9:19 am

larryswedroe wrote:what we are seeing is a liquidity crisis which will come to an end once the deleveraging comes to an end.
Even in the Great Depression AAA munis held up well, and this will not be anywhere near that situation when 35% of industrial production evaporated and 25% unemployment was hit
Larry, I looked up some info a week or so ago and found the same data regarding munis during the Depression. However, what do we know about the condition of finances of the states and municipalities back then as compared to now? I guess that what ratings are for. After the ratings scandals in derivatives, who knows.

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Post by bob90245 » Fri Oct 17, 2008 11:00 am

There is a real possibility that higher than normal muni yields are a signal of higher than normal risk. I wouldn't ignore the danger.

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Post by wab » Fri Oct 17, 2008 11:08 am

bob90245 wrote:There is a real possibility that higher than normal muni yields are a signal of higher than normal risk. I wouldn't ignore the danger.
10-year treasury yield is 3.91% (riskless).

10-year tax-eq muni yield is 6.51% and tax-free is 4.62%.

Plenty of margin for risk, don't you think?

I think the main risk is interest rate risk, but treasury rates may be artificially low, so we could see that spread compress even without a change in muni rates (i.e., current lower NAV may persist).

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Post by m_j_paquette » Fri Oct 17, 2008 12:41 pm

bob90245 wrote:There is a real possibility that higher than normal muni yields are a signal of higher than normal risk. I wouldn't ignore the danger.
There may be some risk there but most of the current high yield appears to be due to asset liquidation into a relatively illiquid market.

Unlike corporate bonds, munis are backed by the taxing authority of government. Even when an issuing organization goes bankrupt, the courts give a high priority to paying off the bonds. The default rate as a portion of the total muni market is up slightly this year, but nothing like the levels back in 1991.

The ratings on munis are not readily compared to corporate bond ratings. Moody's has been working on a re-rating project recently for munis. http://www.moodys.com/cust/content/cont ... 249_rm.pdf

I ran across this little graph of default rates:
Image

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Post by wab » Fri Oct 17, 2008 12:49 pm

Moody's data only goes back to 1970. It would be nice to see the worst-case cumulative default and recovery rates given all the 100-year floods we've been having.

And remember that this liquidity crunch is having two effects: increasing yields on some bonds and decreasing yields on treasuries, so we need to be careful when comparing to current treasury yields.

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Post by bob90245 » Fri Oct 17, 2008 12:53 pm

m_j_paquette wrote:Unlike corporate bonds, munis are backed by the taxing authority of government.
This could be the problem. A bad economy causes higher unemployment and lower corporate profits -- thus reducing the income pool available to be taxed.

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Post by cheapskate » Fri Oct 17, 2008 12:54 pm

VWSTX and VMLTX, the 2 muni funds I own have served as (relatively) safe havens amidst all of the turmoil. VWSTX is up 1.95% YTD ad VMLTX is up about 0.05% YTD. I am happy with both of these (together they formed 100% of my FI allocation).

But I did rotate from VMLTX to VIPSX. Could not resist the juicy real yields on TIPS. And longer term, I would like about 50% of my FI allocation in TIPS, just think this is a good time to move into it.

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Post by wab » Fri Oct 17, 2008 12:57 pm

bob90245 wrote:This could be the problem. A bad economy causes higher unemployment and lower corporate profits -- thus reducing the income pool available to be taxed.
This is clearly priced in. In fact, it looks like a 5% default rate (assuming 50% recovery) is priced in. Compared to a historical 0.1% 10-year cumulative default rate.

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Post by Gregory » Fri Oct 17, 2008 1:56 pm

daryll40 wrote:Kinda sorta right. It's true that your coupon goes up as prices fall.

It's sort of like owning a home and living there for 30 years. The value may go up and (like now) it may even fall. You don't care because you don't plan to move. But the value is still the value and it may, indeed, be less or more.

Sort of like the old "it's only a paper loss" argument. Yeah, paper loss but CONVERTIBLE into less REAL STUFF!
With my zero-coupon muni's I know there's a very good chance I'll get all my money back. I can see why Larry prefers individual bonds, and why his firm seems to favor individual bonds for its clients.

Again, I don't expect anything of my VWIUX shares except the coupon -- I expect the NAV to fluctuate.

Greg
Pecuniae imperare oportet, non servire. | Fortuna vitrea est; tum cum splendit frangitur. -Syrus

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DaveTH
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Post by DaveTH » Fri Oct 17, 2008 2:08 pm

Gregory wrote:I don't expect anything of my VWIUX shares except the coupon
And what would that be given that a fund does not have a fixed yield?

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Post by wab » Fri Oct 17, 2008 2:22 pm

DaveTH wrote:
Gregory wrote:I don't expect anything of my VWIUX shares except the coupon
And what would that be given that a fund does not have a fixed yield?
It should be roughly $0.045 per share per month.

The coupon (distribution) should be stable even if the yield (dividend/price) varies.

(Edit: oops, I was off by a factor of 10. Distribution corrected.)
Last edited by wab on Fri Oct 17, 2008 11:04 pm, edited 1 time in total.

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Post by Gekko » Fri Oct 17, 2008 4:57 pm

hey! my muni fund is *up* .02 today! it's a win! i'll take it!

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Post by Gregory » Fri Oct 17, 2008 10:31 pm

DaveTH wrote:
Gregory wrote:I don't expect anything of my VWIUX shares except the coupon
And what would that be given that a fund does not have a fixed yield?
Dividend payment history as follows, with 8 bp ER:

$0.04462 09/30/2008
$0.04497 08/29/2008
$0.04546 07/31/2008
$0.04453 06/30/2008
$0.04580 05/30/2008
$0.04450 04/30/2008
$0.04632 03/31/2008

http://tinyurl.com/6ogs92

Thanks for asking.
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CA bond issuers unlikely to default?

Post by djw » Fri Oct 17, 2008 10:59 pm

newport1 wrote:

"I find it hard to believe that the default rate on CA bonds is likely to exceed that of high-grade corporates."

Is newport1 aware that the gap between California's proposed state budget expenditures and its expected tax revenues is 24%?

Arizona, Nevada, and Florida state budgets are in similar dire straits.

Has newport1 read the press reports that California's governor (a Republican) has already gone begging to Washington for a bailout?

Is newport1 aware that some CA cities and towns have previously defaulted on their bonds and that several currently appear to be on the verge of doing so in the near future?

Is newport1 aware that CALPERS and other CA entities are known to have made large, losing investment bets which are coming home to roost?

I've never owned any munis and, all things considered, I won't be buying any munis any time soon.

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Re: CA bond issuers unlikely to default?

Post by newport1 » Sat Oct 18, 2008 12:31 am

djw wrote:newport1 wrote:

"I find it hard to believe that the default rate on CA bonds is likely to exceed that of high-grade corporates."

Is newport1 aware that the gap between California's proposed state budget expenditures and its expected tax revenues is 24%?

Arizona, Nevada, and Florida state budgets are in similar dire straits.

Has newport1 read the press reports that California's governor (a Republican) has already gone begging to Washington for a bailout?

Is newport1 aware that some CA cities and towns have previously defaulted on their bonds and that several currently appear to be on the verge of doing so in the near future?

Is newport1 aware that CALPERS and other CA entities are known to have made large, losing investment bets which are coming home to roost?

I've never owned any munis and, all things considered, I won't be buying any munis any time soon.
Newport 1 is actually a pretty smart guy. The historical default rate on munis is materially less than corporates. The state has bridged much of its shortfall with the revenue anticipation notes it floated this week. What the hell does the governor being a republican hve to do with anything??

My point was that munis are a good buy on a relative and risk-adjusted basis.

I really don't care what you own or don't want to own. Also, you should deal with your hostility issues.

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Post by superlight » Sat Oct 18, 2008 2:18 am

It will be really too bad if munis crap out, because they are the only real tax-safe retirement option. Anything else is a gamble about future capital gains tax and future tax rates on 401k/ira withdrawals.
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Re: CA bond issuers unlikely to default?

Post by Gregory » Sat Oct 18, 2008 9:04 am

newport1 wrote:The state has bridged much of its shortfall with the revenue anticipation notes it floated this week.
The Gov. felt the need to take to the airways via radio ads to encourage people to "invest in California" and buy these notes. The State raised $5B, they need about another $2B.
Pecuniae imperare oportet, non servire. | Fortuna vitrea est; tum cum splendit frangitur. -Syrus

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Post by Gregory » Sat Oct 18, 2008 9:22 am

superlight wrote:It will be really too bad if munis crap out, because they are the only real tax-safe retirement option. Anything else is a gamble about future capital gains tax and future tax rates on 401k/ira withdrawals.
If you're concerned about falling NAV, David Swensen (who favors Treasuries because of lack of call options, uncertainty and credit risk) says that "For shorter-term maturities, the negative factors cause investors far less concern. In the case of a tax-exempt money-market fund, the near-dated maturity of the underlying securities obviates concers regarding tax regime changes and mitigates concerns regarding credit risk. Money-market instruments carry no call options and trade in relatively efficient transparent markets. Short-term tax-exempt money-market funds deserve serious consideration." Unconventional Success, pp. 117-118.

Vanguard's Vanguard Tax-Exempt Money Market Fund (VMSXX) currently holds about $23.4B in assets, so lots of people must feel comfortable with this choice as a part of their AA.

How would one fare long-term? While financial past may not be prologue:
$10K invested 10 years ago is today worth:
VG Muni MM (VMSXX) $12,798
VG IT Muni (VWITX) $14,522
VG TSM (VTSMX) $13,696
Pecuniae imperare oportet, non servire. | Fortuna vitrea est; tum cum splendit frangitur. -Syrus

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Post by Tall Grass » Sat Oct 18, 2008 12:29 pm

Never used munis...never will.
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Post by daryll40 » Sat Oct 18, 2008 12:48 pm

Why not?

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Post by Gregory » Sat Oct 18, 2008 2:05 pm

Tall Grass wrote:Never used munis...never will.
If they're good enough for Mr. Bogle and for Larry, then they're good enough for me.
Pecuniae imperare oportet, non servire. | Fortuna vitrea est; tum cum splendit frangitur. -Syrus

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Re: CA bond issuers unlikely to default?

Post by tfb » Sat Oct 18, 2008 2:41 pm

Gregory wrote:
newport1 wrote:The state has bridged much of its shortfall with the revenue anticipation notes it floated this week.
The Gov. felt the need to take to the airways via radio ads to encourage people to "invest in California" and buy these notes. The State raised $5B, they need about another $2B.
I don't think there was any question about whether California would be able to raise money on notes due next May and June. At what rate was the question. If taking to the airways lowered their funding cost by 0.25%, it was a very good investment by State of California.
Harry Sit, taking a break from the forums.

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Post by ilan1h » Sat Oct 18, 2008 11:56 pm

65% of my portfolio was in calif interm munis. I bought them when they were around 11 and followed them down to 9.8. A fairly significant loss over the last year. Last week I decided to tax loss harvest and sold the entire position. Now I find myself strangely unwilling to buy back once the month is up. Somehow, it's erratic behavior has me spooked. I think that the fact that the calif MM muni yield was fluctuating to almost idiotic extremes was particularly scary. Really makes one wonder what is going on.

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Re: Time to re-think muni's as safety anchor?

Post by Qtman » Sun Oct 19, 2008 4:47 am

Everyone needs to look at munis for what they want from them. Munis bounce all over on a mark to market daily basis, this will drive some people mad.

I use munis (only GOs and revenue from projects I am familiar with) to provide a steady cash flow that I then take and reinvest in other asset classes. With individual bonds you know held to maturity your principal comes back and with funds you get monthly cash flow for consistency.

Yes there is interest rate risk, which is why until I need the cashflow to live, I reinvest inerest in various equites, more bonds or their equivalent mutual funds with Vanguard.

After tax equivalent yields are looking pretty decent.
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