You might assume that all of the bonds in the fund are from issuers in your state. You might be surprised to find that the fund also owns Puerto Rico debt. For years most investors didn’t think much about this as the debt still had the same tax advantage as their state debt, and Puerto Rico was viewed as a stable credit that provided some yield.
With the downgrade of the debt, I expect that investor sentiment is going to shift. Municipal bond fund investors should, and I expect will, want to take a closer look at their state muni bond fund to understand their Puerto Rico exposure.
I don’t know what will ultimately happen with Puerto Rico debt. Given the current trajectory of their economy and deficit it seems likely that some sort of restructure of their debt may be necessary.
For this risk longer maturity bonds are yielding over 8%, and that’s more than 13% on an after tax basis for folks in a 40% or greater tax bracket. A good value? Only time will tell. For now, just make sure that you know what you own and are comfortable with the risk.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog. You can find more of his posts here.