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 capital gains distributions are taxable as capital gains. Additionally, a portion of some funds’ distributions may be taxable or increase AMT exposure for some investors.
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?
The Rochester team manages seven single-state funds in four states: New York, California, Pennsylvania, and New Jersey. Each portfolio holds many types of muni securities and all produce net investment income that is exempt from federal, state and, where applicable, local income taxes.
Our single-state funds are:
- Oppenheimer Rochester Fund Municipals (for New York investors)
- Oppenheimer Rochester Limited Term New York Municipal Fund
- Oppenheimer Rochester AMT-Free New York Municipal Fund
- Oppenheimer Rochester California Municipal Fund
- Oppenheimer Rochester Limited Term California Municipal Fund
- Oppenheimer Rochester Pennsylvania Municipal Fund
- Oppenheimer Rochester New Jersey Municipal Fund
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. The purchase of below-investment-grade issues is limited to 25% of fund assets for our long-term single state funds in New York, California, Pennsylvania, and New Jersey and to 15% of fund assets for our limited term funds in New York and California1. Additionally, the limited term funds seek an average effective maturity (AEM) of 5 years or less, while the long-term funds investors have no set AEM target.
New York investors who have paid the alternative minimum tax (AMT) in the past – as well as those who worry that they may have to pay it in the future and those who simply don’t like guessing about taxes when they invest – may wish to consider Oppenheimer Rochester AMT-Free New York Municipal Fund. This single-state fund will not increase an investor’s AMT exposure.
Read some competitors’ prospectuses carefully, and you’ll discover several funds that are merely “close to AMT free,” with as much as 20% of assets in the private-activity bonds that can increase an investor’s AMT exposure. In contrast – and to the benefit of investors subject to AMT – this fund’s portfolio does not include any private-activity bonds.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 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.
- ^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.
- ^U.S. investors who do not live in the New York State but seek to avoid any additional exposure to AMT may wish to consider Oppenheimer Rochester AMT-Free Municipal Fund
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 and possessions, and could be exposed to their local political and economic conditions.