The general rule on Wall Street is that whenever investors want more of something, the Street is happy to oblige -- usually with securities that would have been better left uncreated.
It worked that way earlier this year with absurdly high-risk initial public stock offerings, for example, and with Internet-only stock mutual funds.
But the Street hasn't been able to do much for the horde of investors who've been lining up to buy tax-free California municipal bonds this year: While demand is way up, the supply of new bonds has waned.
In the often upside-down world of finance, this is good news. It is making for some very appealing returns in the muni market. And the opportunities still look attractive for investors hungry for high yields and eager to add an element of capital preservation to their portfolios.
Do bonds bore you? Or you just don't understand them? Then you're in the majority, not the minority. It's OK to feel sheepish about bonds. But with the yields available on California munis today, your eyes should quickly unglaze: Depending on your tax bracket, you would have to earn 7 percent, 8 percent or more in annualized yields on corporate bonds or bank CDs to equal what munis are paying.
If those numbers still don't sound like much in a world where individual technology stocks can easily rise 20 percent or more in a day, you may be interested to know that one of the key sources of demand for California munis this year has been the Silicon Valley and Tech Coast crowd.
''There is a lot of demand from the IPO millionaires, the Internet millionaires,'' says Stephen Galiani, managing director of the muni bond group at Wells Capital Management in San Francisco.
''As people become wealthier they become more conservative with their money,'' Galiani says. Many muni bond buyers today have already enjoyed much in the way of capital appreciation; now they're looking for capital preservation -- which is what bonds are all about.
First, a bit of background on the muni bond market to explain where we are today: Munis are IOUs issued by states, municipalities and local government agencies. They typically fund long-term building projects (sewers, roads, schools, etc.) or are used to manage cash flows (shorter-term muni IOUs, for example, may be used to fund a government entity's operations until tax payments are received).
Despite some high-profile problems over the last few decades -- such as Orange County's bankruptcy in the mid-1990s -- the simple fact is that muni bonds have been extremely safe investments. Defaults happen, but they are rare.
Like Treasury or corporate bonds, most muni bonds pay a fixed rate of interest to the bond holders for the life of the security. At maturity, you then get back the face value of the bond (say, $1,000).
What's different about munis is that the interest they pay is usually exempt from federal income tax and also from state income tax in the state where the securities are issued.
The double tax exemption allows muni issuers to pay lower rates of interest to borrow, because the true yields -- the ''taxable equivalent'' yields -- are much higher for the buyers of the bonds, courtesy of the tax exemption.
That's why many investors have turned to munis this year. Muni yields, particularly on long-term bonds (maturing in 10 or more years), are extremely attractive relative to most alternatives, including U.S. Treasuries, which are federally taxable but not state taxable.
As of Friday, Galiani said an investor looking for the highest-quality muni issues in California could snare yields of 4.30 percent on five-year bonds, 4.65 percent on 10-year bonds and 5.10 percent on 15-year bonds.
Yields might be even higher were it not for the thin supply: California issuers, including the state and all local entities, have sold $11.5 billion in new bonds this year. That's down 23 percent from the first-half of 1999.
Flush with cash from the strong economy, local governments' borrowing needs are down, notes Zane Mann, editor of the California Municipal Bond Advisor newsletter in Palm Springs, Calif. Issuance should pick up somewhat in the fall, but perhaps not enough to satisfy demand.
The upshot of robust demand is that it's boosting the market value of existing bonds. That's why, if you look at the year-to-date ''total returns'' listed for California muni bond mutual funds, you'll see many funds are up 6 percent or more this year. That factors in the interest they've already paid for the half year, plus the rise in the market value of the bonds in the portfolios.
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