Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income

CHAPTER 5

Professionally Managed High Yield Municipal Products

Now that we understand in detail the risk/return characteristics of high yield municipals as an asset class, how can an investor get access to this sector? Packaged fund products come to mind first, as they can provide the kind of portfolio diversification that is a key requirement for successful high yield tax-exempt investing. Before proceeding, we should note that “diversification” does not mean just slapping together a bunch of different issues in different sectors. You need to think about what the major credit drivers are for each of your bond holdings and ensure those drivers overlap as little as possible. For instance, it is customary to classify the senior retirement and multifamily housing sectors as separate and distinct sectors, whereas they in fact share a fundamental dependence on local real estate factors. Proper diversification should occur along geographical and sectoral lines as well as by security types (e.g., tax-backed bonds versus utility bonds, etc.). The beauty of the high yield market lies in the fact that most of the time, micro—not macro—factors drive the credit, a feature that you should optimize in constructing your portfolio.

Unfortunately, for the majority of investors out there, assembling a truly diversified portfolio is not an easy feat if you have less than, say, $10,000 to devote to this strategy. After all, the minimum face value of a muni bond is already $5,000. In that case, professionally ...