Is This a Better Bond?

States and municipalities have jumped on a new bond program, selling $12 billion of Build America Bonds since the program began in mid-April. The issuers have benefited from lower borrowing costs. What?s in it for individual investors? So far, not much. The Build America Bonds were tucked into President Obama?s stimulus plan to lower borrowing costs for states and municipalities in their time of need. But as with much of the stimulus plan, they?re a bit confusing and may not be the boon they initially seemed to investors.

The rationale for the bonds is this: The Feds help state and local governments issue bonds to finance projects that repair our infrastructure and put people to work; 35 percent of the interest payments the bond issuers offer investors is subsidized by the federal government. But Build America bonds are municipal bonds with a twist ? their yields are not tax-exempt. Nearly $12 billion of Build America Bonds were issued in the first two months of the program.

Mom-and-pop investors, by far the biggest buyers of municipal? bonds, have had trouble getting their hands on Build America bonds, since they?re sold to institutions through methods that favor the biggest buyers. For instance, early issues of the bonds came in long-dated maturities that help life insurance companies and pension funds match the debt to their future payout obligations but don?t do much for retail buyers. As a result, Build America bonds have been very popular with large institutions, says Paul Brennan, who oversees $12 billion in municipal-bond funds as portfolio manager at Nuveen Asset Management. That popularity has also driven down yields (as bond prices rise, yields fall). So even when retail investors can access Build America bonds, in most cases they?re still better off in traditional municipal bonds for the tax exemption, Brennan says.

But there?s another drawback for muni-bond investors: Build America bonds are reducing the supply of tax-exempt munis coming to market. States and localities have held off on some $100 billion worth of projects, many of which are now being financed with Build America bonds, says Matt Fabian, managing director of Municipal Market Advisors, a strategy and research firm. Fabian says investors may start seeing Build America bonds in their muni funds, since their strong showing to date means they could boost the funds? performance. But if you?re looking for a tax-free yield, stick with a fund that avoids them. Still want that boost? Several corporate-bond funds have been buying Build America bonds as well.

2009 Copyright The New York Times Syndicate