Some stock-battered investors see municipal bonds as possible shelter

Watching the collapse in the stock market, another group of investors had some idea of how their friends were feeling. The people and institutions that invest in municipal bonds have gone through two major downturns this year, though neither was anywhere near the magnitude of Monday's stock market dive. Until this year, municipal bonds had a well-earned reputation for stability, steady income, and modest changes in price. But all that changed in April and May, when municipals lost 10 to 12 percent of their value, and again in August, when several percentage points more were lost.

Since then, the muni bond market seems to have settled down a bit, at least enough to give battle-weary stock market investors a place to put a portion of their liberated cash.

But it might be better to wait awhile.

``I don't see this as a buying opportunity right now,'' says Judd Hennessy, portfolio manager of the CIGNA municipal bond fund. ``But if you're in a fund, and aren't reinvesting dividends, I'd consider it. You're reinvesting dividends at a lower NAV.'' The NAV, or net asset value of a fund, is similar to the share price of a stock, and as the NAV goes down, the same dollar investment buys more shares of the fund.

``The bond market today is right where is was in June of 1985,'' says Terry Trim, vice-president of the American Portfolio Advisory Service, a subsidiary of Van Kampen Merritt Inc. ``So we've returned 2 years of gains.''

``It's a lot better time to be in munis than it was six months ago,'' said Arthur L. Schwarz, president of Erlich Bober Advisors in New York. ``But we're still very cautious investors. Choosing the right sector is very important.''

For now, Mr. Schwarz says, the right sector is mainly defined by time and some sort of insurance. For him, time means three to five years; any bond bought now shouldn't have a maturity longer than that. And insurance means Treasury securities. There are several bond issuers, he says, that have invested the money they will need to make coupon payments in United States Treasury bonds and notes.

``So you've got a municipal bond that's backed by obligations of the US government, which has a great advantage over everyone else - it can print money - and a tax-exempt yield of 9 percent until 1990 or '91.''

That's not bad for a muni bond market shaken by unheard-of volatility this year. Much of that volatility was brought on by tax reform. The 1986 tax revision left many states and municipalities uncertain about the new rules for issuing bonds. As a result, there were fewer bonds issued, and some municipalities that are considered bellwethers of the market stopped issuing tax-free bonds altogether, or have started issuing taxable bonds.

In addition, federal regulators began looking closely at several dozen recent bond issues that may have conflicted with the new regulations.

Another indication of the condition of the muni market came last week when Salomon Brothers, one of the largest dealers in these bonds, announced it was pulling out of the business. The next day, Kidder, Peabody Group Inc. said it would be trimming 100 employees from its municipal staff. Both moves were seen as indicators that municipals wouldn't soon recover from the slump they have been in since the Tax Reform Act was passed.

And all of these factors have combined to make many investors decide to wait awhile before buying municipals again.

But now, ``Tax reform has sort of been wrung out of the system,'' Mr. Trim says. ``Tax reform is a fact of life now, and a tax-free bond is a tax-free bond.''

At 9 percent, those tax-free bonds are only slightly under the 9.8 to 10 percent level on 30-year US Treasury bonds, where the after-tax yield could be as much as 33 percent lower.

To protect that handsome return, many investors are looking for some kind of municipal bond insurance. While insurance won't protect the interim value of your bond if the bond market goes through another collapse, it will cover principal and interest payments for the life of the bond. So long-term bondholders who aren't prone to trade in and out of their bonds shouldn't have to worry.

You can also get insurance on pools of bonds, or unit investment trusts, also known as UITs. While their 8 percent yields are lower than those on straight, uninsured bonds, ``UITs have a little better price performance,'' and often, less volatility, Trim says.

Investors who do want to buy munis directly - and defensively - might consider staggering their purchases. This would mean a portfolio of bonds with maturities in 3, 5, 7, and 12 years. In this way, bonds would be maturing every two to three years and the proceeds could be put into higher- or lower-earning bonds, depending on the market.

If you have a question that would make a good subject for this column, send it to Moneywise, The Christian Science Monitor, One Norway St., Boston, MA 02115. No personal replies can be given. References to investments are not an endorsement or recommendation by this newspaper.