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

Six Basic Tenets of High Yield Municipal Investing

A profitable high yield strategy goes well beyond clipping the high tax-exempt coupon. When done properly, it can result in total return performance that, as we have seen above, can rival equities. In this section, we will go over the six basic tenets of a successful tax-free high yield strategy, namely: invest for after-tax total return, not just yield; respect the credit and interest rate cycles; always own the best relative values in the marketplace; implement true portfolio diversification; manage for liquidity; and pay attention to dollar price.

Invest for After-Tax Total Return, Not Just Yield

With respect to high yield investing, fixed-income professionals tend to be split between two major schools of thought: the income compounding approach and the total return approach.

The income compounding approach argues that the investor should always focus on earning the maximum yield while managing credit risk. After all, a dollar of tax-free interest income is worth much more than a dollar of capital gain. Over time, assuming one can steer clear of serious credit problems, the compounding effect of earning the additional yield premium should allow the bondholder to realize an above-average rate of return on his or her investment. The objective is to assemble a portfolio of the highest yielding tax-free securities, within the constraint of your investment guidelines; monitor the portfolio for credit changes and adjust the credit ...