I’ve been an investor in VMATX which is Vanguard’s Massachusetts Municipal Tax Fund over the last 2 years. A few years back, I had thought about constructing my own bond portfolio, but found it too much of a hassle. The commissions were expensive, researching bonds were difficult, and it was unclear what benefit I really gained.  Certificates of Deposits yielded similar rates.  Bond funds such as VMATX performed better but not that much better.

In the last 9 months, the pros have begun to outweigh the cons.  CD rates have plummeted as the economy has soured, and the fed has lowered rates. VMATX is intermediate term bond fund meaning it holds assets on average with a maturity of 5-10 years. The current climate of fear and potential budget shortfalls have made municipal funds risky, and this risk translates into lower prices on the underlying bonds that make up VMATX.  This risk is real, but I think it has been somewhat unfairly applied across the board on all bonds, regardless of issuer.  As a result VMATX and many other bonds funds have taken a hit in price.  VMATX continues to steadily make it’s dividend payments.  The price of the fund has however been uneven over the last year.

Fixed income instruments vary with the general interest rate environment or with the individual risk of the debt issuer.   Typically as interest rates decline as they have over the last year, bonds increase in value.  This is not what has happened this past year.   Bonds of all varieties, corporate and municipal, have decreased in value.  The only exception have been Federal treasuries.

People have fled to the safety of Federal debt, fearing that corporations and municiplalities will end defaulting on their obligations.  Some of this fear is rational, and some overdone.   As a result corporate bond yields have widened.  Safe bonds such as 6 Month Bell South bonds yield less than 1% while Citigroup bonds of the same duration (6 months) yields nearly 33 percent.   I’ve quoted those based on the offer side, yields based on what sellers of the bond are will to take.   If anything the bigger issue currently is the very wide bid/ask spreads.  The bid is what someone is willing to pay and the ask is what someone else is willing to sell at.  For example the bid ask spread on the Citibank bond I cited above is 48%/35%.   The buyer demands a yield of 48% while the seller is only willing to give 35 percent.

The high yields, and the wide bid ask spreads are reflective of bond market that remains uneasy.   There is fear on the street.   Bonds and stocks have both taken a beating, and there are opportunities in both.   I’m still trying to figure out how to best construct my own portfolio.  How to pick bonds that will pay good returns without defaulting.  In this light, it’s very similar to my foray on prosper.com