Municipal bonds don’t default very often and, even when they do, the result for bondholders is rarely the nightmare it’s assumed to be. But that hasn’t stopped some municipal bond fund investors from quaking in their boots—and, perhaps, adjusting their tax-exempt portfolios in ways that undermine their long-term financial objectives—any time they hear the word “default.”
Defaults sound dangerous, and muni bond investors, with their expectations for safety, generally become fearful when anything sounds dangerous. Investors often imagine a doom-and-gloom scenario, but the truth about defaults, we believe, isn’t quite so black and white.
It is reasonable to assume that unrated munis default more often than rated munis, though hard data is scant. In Rochester, our experience suggests that the higher yield we collect on our unrated holdings more than offsets the occasional defaults that will occur in any diverse portfolios of tax-exempt securities. The Rochester-based credit research team regularly analyzes and invests in unrated bonds. Many of which are investment-grade equivalents, which can help boost distribution yields and, under most market conditions, contribute positively to total return.
Experienced investors can benefit from default fears. Whether real or unsubstantiated, concerns about muni bond defaults can contribute to heightened levels of price volatility. If enough risk-averse investors choose to avoid the municipal market, borrowing costs for municipalities and other issuers of tax-exempt bonds can rise and opportunistic buyers—like the portfolio managers for the Oppenheimer Rochester municipal bond funds—will then seek to identify good values and increase their holdings as weaker demand fuels higher yields.
In conclusion, a default is never a good thing but the situation may not be as dire as some would have you believe. Consider this: if the forecast calls for a 30% chance of rain, would you stay inside all day to avoid getting wet? Probably not. Rather, you would realize that it may not rain at all and that, if it rains, it may not happen while you’re outside. To be safe, you’d likely consider a proven approach—like carrying an umbrella—before venturing out.
Like weather forecasts, concerns about muni defaults are frequently overblown. Default concerns, in our opinion, should not keep investors from venturing into the muni market—especially if they are armed with an accurate perspective on default rates and have access to a proven approach, such as the value-oriented, research-intensive and security-specific Rochester style of fund management.
We believe it would be a mistake to let overblown concerns about defaults cloud an investor’s vision or alter an investor’s long-term perspective.