Investors in hundreds of bond funds have been shaken by Puerto Rico’s recent default on most of a $58 million bond payment. That’s because half of all municipal bond funds own Puerto Rican bonds, according to Morningstar, Inc. The bonds have been popular because they carry a triple tax exemption (tax-free for US investors at the federal, state and local levels)…provide diversification…and offer annual yields as high as 8% to 10% for a 20-year government bond. But the US commonwealth has been stuck in recession for nearly a decade, and Puerto Rico governor Alejandro Garcia Padilla has said its $72 billion total debt is not payable. That could mean bondholders would lose a big portion of their investments.
Funds with the greatest exposure include many Oppenheimer and Franklin Templeton funds. Franklin Double Tax-Free Income Fund (FPRIX) recently held 41% of its investments in Puerto Rican bonds…Oppenheimer Rochester Maryland Municipal Fund (ORMDX), 37%…Oppenheimer Rochester Limited Term New York Municipal Fund (LTNYX ), 21%…and Alpine High Yield Managed Duration Municipal Fund (AAHMX), 14%.
What to do: If any of your funds hold more than a 10% exposure to Puerto Rican bonds, consider selling and switching to a bond fund managed by Fidelity or Vanguard, which tend to offer higher-quality, more conservative muni bond funds. For example, Vanguard Intermediate-Term Tax-Exempt Fund (VWITX) has only a 0.24% exposure to Puerto Rican bonds. Don’t fish for bargains in Puerto Rican bonds. They are tremendously risky, and prices will be volatile for years as investors negotiate a debt restructuring.
