Fidelity Target-Date Municipal Bond Funds: a Novel but Unnecessary Idea

Last Updated Jun 27, 2011 9:40 PM EDT

The introduction of a range of target-date municipal bond funds by Fidelity Investments is a response to the fact that muni funds have been all but abandoned lately. Investors yanked a net $23.1 billion from them in the first five months of 2011, according to the research firm Morningstar.

The four Fidelity Municipal Income funds are structured in a way that effectively guarantees a return of capital at a certain time - in 2015, 2017, 2019 or 2021 - which should add a layer of safety and boost the funds' appeal to anxious investors. Before using a shaky, sweaty hand to write a check, however, they should consider the possibility that the funds will not be appreciably less risky than conventional muni funds and that the cost in lost returns of any extra bit of safety may be too high.

The exodus from muni funds follows a run of poor performance in 2010 as investors apparently concluded that fiscal conditions were eroding for state and local governments and that economic and political realities would make it more difficult for officials to resort to Plan A and raise taxes. The new Fidelity funds are designed to guard against a similar downdraft in munis just when investors need to withdraw their money to pay for retirement or their kids' college or some other big anticipated event.

Fidelity deserves credit for introducing the funds when the asset class that they specialize in is out of favor; the industry has a habit of rolling out products with a particular focus 10 minutes before the top in that market. The Municipal Income portfolios, no doubt, will do what they are intended to do and ensure that shareholders get their money back at the end of the specified periods, barring defaults, and produce a return in the meantime that roughly corresponds to each fund's yield at purchase.

There are potential drawbacks, however. A return of capital may not be all that great if interest rates and inflation take a sudden turn upward in the intervening years and the capital buys less, a problem that MoneyWatch's own Allan Roth points out can happen to holders of individual bonds, or a portfolio of them, held to maturity.