Historically, premium-coupon, callable bonds have been a positive for fund shareholders:
Yields Improve As a group, muni investors tend to be risk averse. They generally prefer to buy bonds with high credit ratings and to know with certainty when the principal amount will be paid back. For this reason, they are less likely to buy a bond with a call feature as it introduces an element of uncertainty into the transaction. They usually opt for “bullet bonds,” which have a set date for the return of principal.
The Market Is Inefficient In our experience, many callable bonds do not get called at their first call date. As a result, the callable bonds we purchase generate higher amounts of tax-free income to the first call than bonds that mature on the same date. If the bond s are not called on that date, even more tax-free income is generated. Our portfolio management team looks at a variety of bonds and sectors every year, and this provides strong insights about which issuers and sectors have a history of ignoring their bonds’ first call dates.
The Bond’s Price Stabilizes Once a kicker bond becomes callable, it tends to trade close to par and to be relatively stable in price. Other investors may be jealous of the income these bonds are paying, but most are hesitant to bid on them given the possibility that the bonds could be called soon after they were bought at a premium. Our shareholders benefit from the price stability caused by this reluctance.
We Have Large Portfolios Unlike the individual investor who holds a laddered portfolio of 10 to 50 investments staggered with different maturities, each of our 20 muni bond funds has significantly larger holdings and usually more capital to deploy. While an investor with a small ladder might have a majority of bonds called in a narrow timeframe, it is far less likely that a large fund would be in similar straits.
The funds most likely to buy premium-coupon, callable bonds are our 5 “maturity managed” funds:
- Oppenheimer Rochester Short Term Municipal Fund
- Oppenheimer Rochester Limited Term Municipal Fund
- Oppenheimer Rochester Limited Term California Municipal Fund
- Oppenheimer Rochester Limited Term New York Municipal Fund
- Oppenheimer Rochester Intermediate Term Municipal Fund
Premium-coupon, callable bonds play a vital role at Oppenheimer Rochester, especially in our managed maturity portfolios. Because they typically trade like short bonds, they exhibit less volatility than their final maturities would suggest. Additionally, they provide our funds and shareholders with higher amounts of tax-free income than short maturity bonds would. We’ve used this unique strategy for many years and believe it truly benefits our shareholders.