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					January 2008




                                         Taxable Municipal Bonds: An Investment Opportunity
                                                                                                                         by Rip Reeves

One of the chief responsibilities of portfolio managers is to          Second, taxable municipals have low credit risk, and issuers almost
be on the lookout for attractive investment opportunities that         never default – unlike some taxable investment-grade corporate
make sense for our clients’ portfolios – and to ask for changes        issuers of recent years. Taxable municipals also have no LBO risk,
in portfolio guidelines where necessary in order to exploit these      given the quasi-public nature of their issuers.
opportunities on behalf of our clients. At the moment, we see
an allocation to taxable municipal bonds as an attractive way to                    Ten-Year Cumulative Default Rates
increase both portfolio income and potential total return without a                            1970-2000
commensurate increase in overall risk, however risk is measured.                                           Munis          Corporate
                                                                           AAA                             0.00%            0.68%
Taxable municipals are generally private activity bonds where a
                                                                           AA                              0.03%            0.80%
significant portion of the issue proceeds benefit a private rather           A                               0.01%            1.47%
than a public source, making them ineligible for federal tax               BBB                             0.06%            4.86%
exemption. Typical uses of proceeds are replenishing an under-             Investment Grade                0.03%            2.32%
                                                                           Speculative Grade               1.93%           32.04%
funded pension plan, financing investor-led housing or athletic
stadiums, and refunding a previously refunded issue. The taxable           Source: Moody's
municipal market has grown significantly in recent years and now
represents approximately 6% of the total municipal market of $2.5
trillion. Issuance has averaged $30 billion annually over the last     Third, taxable municipals have historically provided lower volatility
five years, while 2007 issuance through September has reached $19       of returns than other taxable sectors. The return streams of taxable
billion. Taxable municipals have been included in the Lehman           municipals have been much more stable than those of corporate
Brothers Aggregate Bond Index since 2003.                              bonds.

Taxable municipal bonds possess several qualities that make them              Volatility (Standard Deviation of Total Return)
particularly attractive for inclusion in investment-grade insurance                        3 yrs ending 9/30/2007
portfolios. First, as shown in the table below, taxable municipals          Taxable Muni                             4.41%
offer an attractive yield spread over Treasuries. Additionally, their        Treasury                                 4.28%
                                                                            Agency                                   4.57%
yield advantage compares favorably to lower-rated taxable corporate
                                                                            Corporate                                5.32%
bonds.
                                                                            Source: Standish
    Taxable Bond Spread vs. Treasury (5 YR Maturity)
                        12/31/2007
   Taxable Muni AAA Insured             +120 BPs
   Taxable Corporate Industrial AAA      +63 BPs
                                                                       Fourth, the majority of taxable municipal bonds have no call
   Taxable Corporate Industrial AA       +88 BPs                       feature and thus no prepayment risk. While some housing bond
   Taxable Corporate Industrial A       +116 BPs                       issues may have embedded prepayment options, PAC structures
   Taxable Corporate Industrial BBB     +173 BPs                       generally serve to provide prepayment protection for investors.

   Source: JP Morgan, Standish
January 2008




                                             Taxable Municipal Bonds: An Investment Opportunity
                                                                                                                                       by Rip Reeves


Fifth, taxable municipals are priced and commonly traded off                         Besides offering strong relative value in today’s markets, taxable
the US Treasury yield curve, so they are closely correlated to US                   municipal bonds possess certain inherent and longer-term
Treasuries. Their average yield beta is 0.95. As a result, adding                   advantages that make them attractive candidates for inclusion in the
taxable municipals does not complicate the portfolio duration                       opportunity set of investment-grade insurance portfolios. Taxable
decision, as can tax-exempt municipals, which have a much lower                     municipals offer high quality, attractive yields, and low risk, in
yield beta to Treasuries.                                                           terms of both credit and volatility, particularly when compared to
                                                                                    taxable corporate bonds. We expect issuance to continue to trend
Every investment has its risks. The chief risk in owning taxable
                                                                                    higher with increasing demand, as both institutional investors
municipal bonds is their relative illiquidity. Taxable municipal
                                                                                    (insurance companies, pension funds, and foreign buyers) as well as
issues are generally smaller in size, averaging $33 million for 2006;
                                                                                    individual investors begin to take advantage of this attractive and
and the heaviest trading activity tends to be concentrated in the
                                                                                    growing investment opportunity.
largest issues. Given the relatively higher cost of transacting in this
market, these bonds should probably be thought of as longer-term
“core” holdings in the portfolio. We currently recommend a 5%
allocation in taxable bond insurance portfolios.




                                          One Boston Place, Suite 2900 · Boston, Massachusetts 02108-4408
This information is not provided as a sales or advertising communication. It does not constitute investment advice. It is not an offer to sell or a solicitation of an
offer to buy any security. Past performance is not an indication of future performance. This information is not intended to provide specific advice, recommendations
or projected returns of any particular Standish product. Some information contained herein has been obtained from third party sources and has not been verified by
Standish Mellon Asset Management Company LLC. Standish makes no representation s as to the accuracy or the completeness of any information herein.

				
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