Obviously, the rating agency debacle has raised concerns about the credit worthiness of these State backed instruments. How do we know a rating company's AAA actually means AAA? Does a muni being "insured" mean anything anymore if the company insuring the bond cannot pay upon a bond's default?

In the many years I have been involved with munis as a banker and an investor I relied upon Moody's and Standard and Poor's to provide the base line for my research of these bonds. But I always relied upon my own review of the bond and the type and sector of the bond as well as the state of issuance finances before making a final purchase decision.

But now the game has changed. With taxing authorities under criticism and scrutiny for participating in higher yielding CMO's, CDO's and bundled financial products of all different origins the full faith and credit of even the issuing state has become of greater concern. The specifics of a water management or hospital revenue project bond is no longer the end of the story. Now it has become just the beginning.

Even if you have the background, time and inclination to tear these bonds apart, along with the bond insurer as well as the issuing state and the specific project's solvency issues, it would take a very large municipal bond portfolio to create the diversification necessary to protect your portfolio from the default of one major bond holding. It would take some very large capital gains or years of dividends to get back to even.

I believe a new approach is called for in purchasing this once safety-first asset class.

One approach would be to rely upon the large bond houses and their extensive research to steer a muni investor through the new minefields. While you may have a potential legal recourse in the event of the bond's default, you will pay a very high premium for the bond and the litigation would be cost prohibitive for most small investors. Even in a class action your recovery would be minimal. But for many muni investors the premium they will pay is worth the price of the guidance, protection and possible legal recourse.

I prefer an approach that takes advantage of the extensive research available to the bond houses but allows an investor to purchase the bonds at a discount rather than at a premium. This approach also allows an investor to achieve the diversification of a large bond portfolio and has the liquidity of an equity if the need arises for the funds.

I'm referring of course to Closed End municipal bond funds. The way I approach it is to let the bond house do the background research and assess their own rating while I review the bond portfolio for the type, sector and state of issuance to which I want to be exposed.

I can then determine the net asset value (NAV) of the total bond portfolio and purchase it when it is selling at a discount. This provides additional protection in the event of a default by a bond within the portfolio. In this credit market environment I'm also keeping my bond durations toward the short end of the curve and seeking the highest quality.  

From a practial standpoint, less than one-tenth of one percent of municipal bonds actually default. A statistically small number, unless of course you own that bond. And of course anyone who was around when New York City municipals were defaulting know the fear that hits the market as bonds plunge and the issue of insurance becomes of prime importance.

Since funds invested in municipal bonds are generally considered income producing or "safe" money as I've seen it described, the small probability of default is always balanced against the nature, duration and objectives the funds were invested. Any default in the asset class reverberates throughout the market. For these reasons the availabilty and reliability of municipal bond insurance is of significance.

I have been very bullish on municipal bonds for many months. I still believe they offer the best value, particularly in relation to the spread over Treasuries. I remain a very aggressive buyer of muni's and am constantly looking for closed end funds trading at a hefty discount.

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