Puerto Rico debt roils U.S. municipal bond mutual funds

Tue Sep 3, 2013 11:55am EDT
 
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By Tim McLaughlin

BOSTON, Sept 3 (Reuters) - Nothing says Massachusetts like the John Hancock Massachusetts Tax-Free Income Fund.

But bonds issued by Puerto Rico account for 13 percent of the $101 million municipal bond fund's assets. And like many other municipal bond mutual funds that loaded up on the Caribbean island's debt, the John Hancock fund has generated a dismal return for investors so far in 2013.

Some U.S. money managers have been enticed by the tax-exempt status of Puerto Rico bonds and juicy yields that have topped 8 percent in recent trading.

But danger was lurking. The S&P Municipal Bond Puerto Rico index declined 8.88 percent in August, compared to a 1.68 percent loss in the S&P National AMT-Free Municipal Bond Index, as dealers already spooked by Detroit's bankruptcy fretted about the island's fiscal stability.

In a further sign of the growing perceived risks, Puerto Rico's spread ballooned to 320 points last week, the widest for 10-year bonds over Municipal Market Data's triple-A scale and nearly double Illinois' 165-point spread.

Funds that bet heavily on Puerto Rico are now some of the worst performers among municipal bond funds in 2013, according to an analysis of data from Lipper Inc, a Thomson Reuters service.

Of the 20 municipal bond funds with the highest percentage of Puerto Rican debt, 16 are getting beat by at least 60 percent of their peers.

Puerto Rico bonds are attractive to U.S. municipal bond managers because they are exempt from federal, state and local income taxes in any U.S. state. Investment in Puerto Rico is within bounds for a single-state municipal bond fund as long as at least 80 percent of its income is state tax-exempt, according to the Securities and Exchange Commission's fund naming rules.   Continued...