Morningstar has an interesting article the subject is “Lessons from the Muni Bond Selloff”. The article tries to explain why municipal bond mutual funds drop from early November through late January. The main points have been covered here several times but some points with regard to leverage our interesting.
- Muni bonds sold off in sync with Treasury Bonds
- Several funds that perform poorly, use leverage through an inverse floating rate bond structure called a Tender Option Bond Trust. Leverage is something you want to avoid in a municipal bond mutual fund
- Funds that held a significant portion of tobacco, healthcare, airline, or continuing care retirement communities performed extra poorly.
Morningstar also lowered the rating of the Vanguard short-term tax exempt municipal bond fund (VWSTX,VWSUX) from 3 star to 2 star. This is one fun that we hold, so we took this downgrade seriously. We like this fund because of its very short duration of 1.23 years and high AA average credit quality. You won’t get high yields, but you will get less volatility. We assume it got downgraded because it generated so little in yield.