Muni yields are high, but ratings still suspect, say Deutsche Bank portfolio managers

By Aaron Hochman-Zimmerman

New York, Jan. 28 - Municipal bonds are looking attractive for investment portfolios as the dust settles from the extreme market conditions of 2008, according to Deutsche Bank's DWS Investments.

"I can't turn on CNBC without hearing how good it is to buy munis," said Philip Condon, head of municipal bond portfolio management for Deutsche Bank's DWS Investments.

At the end of 2008, leverage had largely come out of the market and relative yields soared to 190% for a 10-year AAA rated bond versus the comparable Treasury bond, Condon said.

"The market just blew away the old rules," he said.

Ratings lag events

The problems which remained were often the ratings themselves.

"I can't believe we haven't heard more about that," said William Chepolis, head of retail mortgage-backed securities for DWS Investments.

Sometimes "I'm amazed people look at bonds and say, 'Yes, that's AA,'" he said.

The market historically has outpaced the efforts of the rating agencies, but "now it moves much faster than the rating agencies," said Matthew MacDonald, a senior portfolio manager with DWS Investments said.

There is still plenty of value after properly accounting for the risks, Condon said, as high- and medium-grade issues are at "historically wide levels."

Dangers come when people are "focused on one number," Chepolis said about ratings, but the same is true for those who only focus on yield, Condon added.

From the portfolio manager's perspective, Condon emphasized his preference for managed investment where the risks can be reduced through diversification.

"Bond [investment] is much better in a managed portfolio," he said, as opposed to buying piecemeal.

Access, at a price

The market is not without its landmines, but much of the headline risk has been oversold.

Politicians have cried out to Washington, D.C., for more money claiming that they cannot raise capital through the municipal market.

"There's plenty of access to the municipal market," Condon said, it just may require a higher yield payment.

"The spreads in California are now as wide as they've ever been," he said.

Still, with the Obama administration pushing for a further package to boost and bail out the economy, federal money is likely on the way. Even though "we're due for worse numbers before we get better numbers," Chepolis said, the money will serve to support the municipal market.

States' balance sheets will be supported by the influx of cash, which may prevent lay-offs and spending cuts, but will not likely preclude the need for municipal bond issuance, Condon said.

The economic slowdown has become a global beast which has its limits far beyond municipal bonds, but as the market enters 2009, the problems will shift, MacDonald said.

"This is the year of more specific risks," he said, "sectors, names, particular trades."

With a sharper picture of the potential pitfalls, "there are good opportunities in fixed income," he said.

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