Single-state municipal bond funds may be the answer for investors who question the need to pay state income tax on investments that the federal government exempts from taxation.
Owning a single-state muni fund can help limit how much an investor pays in state and local taxes and make it far less taxing to complete state income tax forms.
What many investors like best about single-state funds, we believe, is the favorable tax treatment of the dividend income these funds generate: If you own a single-state fund in your home state, the income that is tax-free on your federal income tax return will also be tax-free at the state and local level. (Please note that a portion of some distributions may be taxable or increase AMT exposure for some investors and that capital gains distributions are taxable as capital gains.)
As many fixed-income investors know, favorable federal tax laws were developed to encourage the investment in municipal bonds and municipal bond funds, which serve to enhance civic life across the United States by financing infrastructure development and community-building initiatives.
Many states, however, have laws requiring investors to pay taxes on income that was exempt at the federal level. We understand that balancing a state budget amid a variety of changing conditions may well be a daunting task for elected officials, but do investors have to give up even more of their hard-earned income? Aren’t investors already coping with state and local governments that seem to be collecting more and allocating less to the services they need?
At Oppenheimer Rochester, we manage single-state funds in 12 states, each of which holds many types of muni securities and all of which produce net investment income that is exempt from federal, state and, where applicable, local income taxes. Of these funds, five long-term funds and 2 limited term funds are currently open to new investors.1
The long-term, single-state funds are:
- Oppenheimer Rochester AMT-Free New York Municipal Fund
- Oppenheimer Rochester California Municipal Fund
- Oppenheimer Rochester New Jersey Municipal Fund
- Oppenheimer Rochester Fund Municipals (for New York investors)
- Oppenheimer Rochester Pennsylvania Municipal Fund
The limited term funds are:
- Oppenheimer Rochester Limited Term California Municipal Fund
- Oppenheimer Rochester Limited Term New York Municipal Fund
Like the entire suite of Oppenheimer Rochester muni bond funds, these funds strive to generate yield-driven total returns, which our seasoned investment team believes can help shareholders achieve their personal goals for tax-free income. To that end, our single-state funds invest across the credit spectrum in a broad range of industry sectors, bond types and maturities.
This approach means that our single-state funds can offer highly effective solutions for investors who seek competitive levels of tax-free yield. Further, because each fund emphasizes in-state securities, your investments also help support projects close to home. Each of our long-term, single-state funds limits its purchases of below-investment-grade issues to 25% of fund assets.2
The Rochester team seeks to lessen the impact of any single risk type by creating sizable portfolios representing a variety of industry sectors and by accumulating bonds with varying maturities, coupons and quality levels. Holding a broad spectrum of credit levels has historically helped our funds deliver the higher yields we seek.
We also diversify across maturities and call dates to reduce reinvestment risk, which occurs when current yields are less favorable than those of the maturing bonds, and call risk, which occurs when an issuer buys back bonds ahead of maturity.
Bondholders may wish to consider the potential effects of idiosyncratic risk, which is the inherent risk of investing in individual bonds; interest rate risk, which is the risk that the value of the bonds may change as interest rates fluctuate; and geographic risk, which is the risk related to economic, regulatory or political developments in a given region. Our single-state funds hold triple-tax-free “territory bonds” – primarily issued in Guam, the U.S. Virgin Islands and the Commonwealth of Puerto Rico – and may invest in inverse floating-rate securities, which are structured to produce attractive yields under certain market conditions. Investors should note that “inverse floaters” tend to exhibit higher levels of price volatility than other structures.
Our single-state portfolios often include a diverse mix of bonds:
High-quality small issues typically reward bondholders with attractive yields and payment schedules. While these bonds may trade less frequently than larger issues, a diverse set of holdings generally offers a fund sufficient liquidity to help achieve its objectives.
Premium-coupon, callable bonds generally provide favorable yields. As these bonds approach their call dates, they tend to have less exposure to interest rate moves and less price volatility than other tax-free investments. Because issuers can be highly inefficient about exercising their call options, we have often collected above-market yields long beyond the bond’s call date. In these instances, the market’s inefficiencies can reduce call risk and reinvestment risk. Premium-coupon, callable bonds are attractive investments because they are priced to a near-term call dates and can be less volatile than bonds with similar maturities. Historically, premium-coupon, callable bonds have been a positive for fund shareholders.
Non-rated issues with solid credit qualities also figure into the investment mix. While most of our holdings have been evaluated by a Nationally Recognized Statistical Rating Organization ( an “NRSRO”) such as S&P Global Ratings, Moody’s Investors Service, or Fitch Ratings, our portfolio managers have enhanced yield over the years by investing with unrated but creditworthy issuers who intentionally forgo the time and expense of obtaining a published rating.
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1 Oppenheimer Rochester also manages long-term muni bond funds in Arizona, Maryland, Massachusetts, Michigan, Minnesota, North Carolina, Ohio and Virginia; effective as of the close of the New York Stock Exchange on March 24, 2016, the purchase and exchange of shares for these eight funds were restricted to existing shareholders, subject to certain exceptions. Please see the prospectus supplements of these funds for further information.
2 For our limited term funds, the purchase of below-investment-grade issues is limited to 5% of fund assets. The restriction is applied at time of purchase and includes unrated securities that are rated internally by OppenheimerFunds, Inc. Market fluctuations or credit rating changes may cause a fund’s holdings of below-investment-grade securities to exceed this restriction. Your financial advisor can provide more information about the limited term and AMT-free muni funds that generate income exempt from state and local income taxes.
Fixed-income investing can entail credit and interest rate risks; as interest rates rise, bond prices generally fall and a fund’s share price can fall, too. A portion of a municipal bond fund’s distributions may be subject to tax and may increase taxes for investors subject to federal alternative minimum tax. Capital gains distributions are taxable as capital gains.
Below-investment grade (“high yield” or “junk”) bonds are more at risk of default and are subject to liquidity risk. Under certain market conditions, some unrated securities may trade less actively than rated securities. Our funds can have a relatively high portion of their portfolio holdings in particular segments of the municipal securities market, such as tobacco bonds or real-estate-related securities. They may also invest substantially in municipal securities within a single state or related to similar type projects, which can increase volatility and exposure to regional issues. Funds may also invest substantially in Puerto Rico and other U.S. territories, commonwealths and possessions, and could be exposed to their local political and economic conditions. Diversification does not guarantee profit or protect against loss.