Why Puerto Rico Matters to Bond Investors
Eileen St. Pierre, The Everyday Financial Planner
While recent events in Greece make front page news, investors may want to pay a bit more attention to what’s happening in Puerto Rico, a U.S. Territory – especially those who own municipal bond funds. As reported by Nightly Business Report (NBR) about a month ago, Puerto Rico faces default on about $72 billion in debt. To put this amount in perspective, New York and California are the only states that have more debt.
NBR also reported that about half of all U.S. municipal bond funds hold Puerto Rican debt. Why should investors care?
Puerto Rican bonds are the only bonds that have a triple tax exemption.
The interest on these bonds is exempt from federal, state, and local income taxes. This is why so many municipal bond funds hold them in their portfolios. Most investors probably never realized they were investing in Puerto Rican bonds. The SEC granted a special exemption to municipal bond funds to do this.
The debt crisis in Puerto Rico should not come as a surprise.
The economy in Puerto Rico has been slumping for more than a decade. NBR reported back on October 8, 2013 that a debt crisis was looming. Many municipal bond funds have since sold their bonds to lower their risk profile, but others kept them to take advantage of rising yields. As long as these bonds made their promised interest payments, the funds that hung on to their bonds outperformed their peers. But now the ride is coming to an end and investors are experiencing losses.
Which municipal bond funds are most at risk?
Morningstar has ranked the Top 20 funds with the most exposure to Puerto Rican debt. They looked at the % of the funds’ assets invested in Puerto Rican bonds as of June 29, 2015.
- The fund with the most exposure is the Franklin Double Tax-Free Income Fund from Franklin Templeton (47.2%).
- All but four of the funds listed are offered by Oppenheimer Funds.
What should investors do?
Hopefully you did not put all your eggs in one basket and invest all your money in just one municipal bond fund. Your portfolio should contain a mix of different types of bond and stock funds.
- To find out how much Puerto Rican debt your municipal bond fund holds, look at the portfolio composition in the last published annual report.
- If it contains only a small percentage (2% or less) of Puerto Rican bonds – and that fund is part of a diversified portfolio – then you should not lose sleep at night worrying about Puerto Rico.
- If your fund contains a larger % of Puerto Rican bonds, particularly if it is one of the funds on Morningstar’s list, then you should talk to your financial advisor.
Another reason to always read the prospectus before investing! Visit my Basic Financial Management page for more information.