Fidelity Target-Date Municipal Bond Funds: a Novel but Unnecessary Idea
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.
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.
Perhaps more important, the designation of specific target dates, and therefore bond maturities, ties the hands of the funds' managers. What if the manager of a fund with a 10-year lifespan is convinced that interest rates are headed higher and would prefer therefore to concentrate his exposure on issues maturing in two years or less? Apparently he is forbidden from doing that.
Fear of rising rates is not what has plagued municipal bonds in the last year so much as fear of default by governments with widening deficits and fewer options for closing them. It's unclear how setting an expiration date for a muni fund will reduce risk for shareholders if defaults rise between now and then.
Another reason that these funds may be of limited use is not that bad things might happen but that they probably won't. The occasional swoon in munis, such as last year and in 2008, seldom lasts long.
Morningstar's figures show that it's hard to lose money in munis over any but the most fleeting holding periods. The average muni fund had a total return of 3.3 percent in the 12 months through June 24 and annualized returns of 4.4 percent over three years, 3.7 percent over five years and 4.0 percent over the last decade.
If you're worried about the muni market taking a dramatic turn for the worse just before you retire, then you could probably do all right buying one of the new Fidelity funds. But if you want to benefit most from the expertise of Fidelity's muni managers, such as the ones who have helped Fidelity Tax-Free Bond (FTABX) earn Morningstar's top rating, five stars, then go with that fund or another one that imposes fewer restrictions on what the portfolio can hold.
When the time comes to limit your risk and make sure that all of your money will be there when you need it, all you have to do is sell and park the proceeds in a tax-free money-market fund. Chances are your pile of cash will have grown bigger by keeping it in a less restricted, more ambitious fund in the meantime.