Morningstar Advisor - December 2013/January 2014 - (Page 21)

Investment Briefs Feeling the Heat From Puerto Rico Largest 25 Funds with 5% or More in Puerto Rico Puerto Rico has struggled with financial problems for a while. Things began deteriorating even before the 2008 financial crisis, thanks in part to a 2006 tax-benefit expiration and the resultant exodus of manufacturers from the island, according to Morningstar municipal credit analyst Candice Lee. The commonwealth's difficulties have only worsened since then, with well-documented strains such as a crumbling infrastructure, high crime, and unemployment all coming up against a contracting economy and weak tax revenue. Although Puerto Rico's bonds bounced back strongly after the financial crisis according to Barclays data, investors began to penalize them more severely in 2012, when, as a group, their returns were less than half that of national muni benchmarks. After the broader bond market began to sell off in May 2013, however, Puerto Rico's fortunes began to slip from bad to worse. Detroit's bankruptcy filing naturally spooked investors, who began looking around to see which might be the next shoe to drop. Negative headlines and new data about the commonwealth's fiscal challenges didn't help matters. Its bond yields had already blown out to an average of 6.8% by the end of September 2013 when Standard & Poor's lowered its outlook on bonds issued by the island's Sales Tax Financing Corp. (COFINA). The U.S. government shutdown that began on Oct. 1 only added insult to injury given that Puerto Rico relies on federal funding for an unusually large percentage of its own government spending. From the start of May through Oct. 1, 2013, Barclays' Puerto Rico Index tumbled 18.7%. That compares with a 4.4% loss for the broader Barclays Municipal Bond Index. Many investors might assume they're immune to those troubles by virtue of living on the U.S. mainland. Those who hold their own Portfolio Weighting (%) Puerto Rico Muni Bonds Return (%) May 1, 2013- Oct. 1, 2013 Fund Size ($Mil) Franklin California Tax Free Income Fund FKTFX 5.1 -6.13 12,728 Franklin High Yield Tax Free Income Fund FRHIX 6.75 -8.17 8,256 PowerShares Insured National Muni Bond PZA 6.14 0 7,808 24.73 -12.22 6,577 8.58 -6.09 5,768 Oppenheimer Rochester National Munis ORNAX 7.79 -10.31 5,535 Oppenheimer Limited Term NY Municipal LTNYX 26.06 -6.33 4,763 Oppenheimer Rochester Ltd Term Muni Fd OPITX 12.88 -5.44 4,591 Goldman Sachs High Yield Municipal Fund GHYAX 8.22 -8.64 3,074 Oppenheimer AMT Free Municipals Fund OPTAX 8.33 -8.83 2,145 Franklin Pennsylvania Tax-Free Incd Fd FRPAX by Eric Jacobson Fund 9.63 -7.12 1,422 Franklin New Jersey Tax Free Income Fund FRNJX 10.61 -6.58 1,391 Alpine Ultra Short Tax Optimized Inc Fd ATOIX 6.99 0.11 1,302 Oppenheimer California Municipal Fund OPCAX 9.56 -8.58 1,298 Franklin North Carolina Tax-Free Inc FXNCX 11.03 -7.51 1,272 Dreyfus New York Tax Exempt Bond Fund DRNYX 8.32 -5.46 1,227 Franklin Oregon Tax Free Income Fund FRORX 10.97 -7.34 1,223 Franklin Missouri Tax Free Income Fund FRMOX 10.98 -6.52 1,206 7.04 -6.25 1,197 19.02 -11.33 1,193 Nuveen NY AMT-Free Muni Inc NRK 5.55 -8.49 1,188 Putnam New York Tax Exempt Income Fund PTEIX 6.78 -5.89 1,100 Dreyfus CA AMT-Free Muni Bd Fd DRCAX 7.29 -6.01 1,059 Franklin Arizona Tax Free Income Fund FTAZX 6.51 -6.26 989 Rochester Fund Municipals Fund RMUNX Franklin New York Tax Free Income Fund FNYTX Franklin Michigan Tax-Free IncFTTMX Oppenheimer Rochester AMT-Free NY Muni OPNYX Data as of Oct. 17, 2013. state's funds might think they're even more insulated than investors with national fund exposure. Unfortunately, the pain has been more widespread than many might guess. The debt of Puerto Rico has historically found its way into a considerable number of mutual funds thanks to a crucial tax advantage possessed by the commonwealth. Owing to its status as a U.S. territory, the island's municipal debt is not only exempt from federal taxes, but state and local levies, as well. That makes it unusually attractive to fund managers, and in particular those who run portfolios invested in narrow, single-state markets with limited and illiquid issuance. In recent years, meanwhile, the relatively high yields offered by Puerto Rico bonds have been extremely enticing to those whose fund sales rely most heavily on the competitiveness of their distribution rates. In fact, there are approximately 180 funds in Morningstar's database-representing more than $100 billion in net assets-that boast weightings of 5% or more in Puerto Rico bonds. 21

Table of Contents for the Digital Edition of Morningstar Advisor - December 2013/January 2014

Morningstar Advisor - December 2013/January 2014
Letter From the Editor
What’s Your Purpose?
Working for Gen Y
How to Allocate College Savings
Mobius Looks to a New Frontier
Investments á la Carte
Investment Briefs
How to Manage Bonds for Today and Tomorrow
Cloud Is the New Engine of Growth
Knowing Where to Look
Economic Vulnerability Varies by Country
Factor Investing in Emerging Markets
Following the Rules
Exploring Indexing’s Next Frontiers
Frequent Fliers
Family Blind Spots
Optimal Portfolios for the Long Run
Finding Value in a Pricey Sector
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Emerging-Markets Roller Coaster

Morningstar Advisor - December 2013/January 2014