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Our Favorite Muni Short Funds
by Scott Berry | 08-01-02
Morningstar’s Fund
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Investors turned off
by rock-bottom money-market yields may find short-term municipal-bond
funds to their liking.
Muni-short funds are
a step up from tax-free money-market funds. They don't offer the
fixed-dollar share price of a money market, but they do offer more
potential return without a lot of added volatility. For the year to
date through June 30, 2002, for example, the average muni-short fund
gained 2.8%, while the average tax-free money market gained just 0.4%.
That pattern holds over longer periods as well, as the average
muni-short fund has outperformed the average tax-free money market by
a considerable amount over the trailing three-, five- and 10-year
periods.
Of course, the added
interest-rate sensitivity of muni-short funds relative to money-market
funds can cause capital losses during periods of rising rates. In 1994
and 1999, for example, the average muni-short fund posted capital
losses of 4.9% and 3.4%, respectively. The added dividend income
provided by the funds offset most of the losses, but the category as a
whole underperformed the average tax-free money market in both years.
Our favorite
muni-short funds include Vanguard Limited-Term Tax-Exempt and T. Rowe
Price Tax-Free Short-Intermediate. Both funds boast solid long-term
records and both have continued to perform well in 2002. Vanguard
Limited-Term Tax-Exempt has continued to benefit from its ultra-low
expense ratio, while T. Rowe Price Short-Intermediate has profited in
recent months from its exposure to the health-care sector.
The muni-short
category could lose some ground if interest rates move higher, but we
think conservative municipal-bond investors will find it to be a
relatively safe haven.
Evergreen
High Income Municipal Bd
VMPAX
This fund is not nearly as conservative as the Vanguard pick, but it
has a solid long-term record (largely as Davis Tax-Free High Income).
Manager Clark Stamper is known for his ability to scour the market for
underpriced bonds. And though the fund stumbled a bit in 1999, it
bounced back strongly in 2000 and earned topnotch returns in 2001.
Strong
Short-Term Municipal Bond In STSMX
This fund also takes on more credit risk than many rivals, as manager
Lyle Fitterer typically holds a large stash of BB and BBB rated
issues. He does, however, keep the fund's duration in a tight two- to
three-year range, which has helped moderate the fund's volatility. The
portfolio will likely lag its peers if there is a flight to
quality--as it did in 2000. However, it remains a good choice for
those who don't mind taking on additional credit risk to capture more
income.
T. Rowe Price
Tax-Free Short-Interm PRFSX
This fund is a solid all-around offering. It boasts a below-average
expense ratio, sticks mainly with high-quality bonds, and has
delivered strong long-term returns. The fund's risk/reward profile is
impressive, and it has consistently delivered a better-than-average
income payout.
USAA
Tax-Exempt Short-Term USSTX
This fund also takes advantage of its low expense ratio. Manager
Clifford Gladson is keen on low- to mid-quality credits, which have
rallied strongly for much of the past few years, bolstering the fund's
long-term returns. At the same time, he keeps duration short and
fairly steady, which moderates volatility.
Vanguard
Ltd-Term Tax-Ex VMLTX
Ultralow expenses are the key here. This category's winners and losers
are often separated by less than 1%, so the importance of this fund's
expense advantage can not be stressed enough. And because of that
advantage, the fund doesn't need to take on lots of extra credit risk
to keep up with the group's more-aggressive members. Quite simply, it
is a terrific choice.
Scott
Berry is an analyst with Morningstar.com.
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