Muni bond funds hit by cash outflows

Investors pulled a net $4.78 billion from tax-free municipal bond mutual funds in the seven days ended Nov. 17, about 1% of total fund assets, as falling bond prices and rising yields depressed muni fund share values.

The outflow, reported Wednesday by the Investment Company Institute, was the biggest in at least three years, and followed the turmoil that rocked the muni market beginning in late October.

A rise in market interest rates in general, and a surge in the supply of new muni bonds from California and other issuers, drove prices of some muni bonds down sharply from Oct. 25 through early last week.

As investors saw the share prices of their muni mutual funds slide, some cashed out.

Shares of the Franklin California Tax-Free Income fund, one of the biggest muni funds, slid from $7.22 on Oct. 25 to $6.82 on Nov. 17, a 5.5% drop. For investors expecting stability in their bond holdings that was a painful hit.

Bond funds in general have lost ground this month as market interest rates rebounded. But taxable bond funds, which include behemoths like Pimco Total Return, still had an overall net cash inflow in the seven days ended Nov. 17, the ICI said. The taxable funds took in a net $457 million, though that was down from $4.06 billion the previous week and was the smallest inflow since March 2009.

Although muni funds? outflow was significant, it should be kept in perspective: The funds had taken in $30 billion in new cash in the first nine months of this year, part of the wave of money pouring into bond funds overall for the last two years. Muni fund assets now total about $500 billion.

The cash-flow data in the next few weeks will be more telling. The muni market rallied beginning last Thursday as investors finally were lured in by the jump in yields. The Franklin California fund?s share price gained 1.6% from Thursday through Tuesday.

The question is whether the turnaround in muni fund share prices was enough to persuade nervous investors to stay put.

A continuing surge in redemptions could trigger another downturn in muni bond prices by forcing fund portfolio managers to dump bonds to raise cash.

-- Tom Petruno