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Wednesday, January 07, 2009

VCAIX, VCITX, iShares S&P California Municipal Bond Fund CMF & CA GO Bonds

Bob Brinker recommended California general obligation (GO) bonds on his show last year. Last weekend a caller said he purchased the Vanguard California Municipal Bond Fund (probably VCAIX or VCITX) and it is down about 2%. He wanted to know if Brinker had any advice now for him.

CMF is the iShares S&P California Municipal Bond Fund.

Brinker said he did not own that fund but he does own General Obligations issued by the State of California which he is holding on to. Brinker said he thinks the great state of California is too big to fail and the federal government will step in to guarantee payment on bonds like it did for New York in the 1970s.

Many investors are in a panic about California's financial crisis. Some Californian municipal bonds are paying an unprecedented tax equivalent rate more than three times as much as Treasuries.

See US Treasury Rates at a Glance

This chart shows the 10-year Treasury is paying about 2.5% now while the table below shows the Vanguard intermediate and long-term CA tax exempt funds are paying 4.15% and 4.64%, respectively.

This could turn out to be the mother of all buying opportunities, or the mother of all muni defaults. Obviously, Bob Brinker is betting on the former. As a California taxpayer, I sure hope Brinker's advice does not turn out to be another bust like his QQQ advice to buy the ETF for the NASDAQ-100 back in late 2000 before it fell from the $80s to the teens.

Table of Vanguard California Tax Exempt Funds and Rates

YTD Returns
as of
S&P 500 Index Fund Inv VFINX 2.84%
CA IT Tax-Exempt Investor VCAIX 4.15%
CA LT Tax-Exempt Investor VCITX 4.64%
CA Tax-Exempt Money Mkt VCTXX0.74%

I must admit that 4.64% tax free is a very attractive yield. I have not been inclined to take risk with my fixed income investments but I may reconsider this . One reason for optimism is president elect Obama will be much friendlier to spending addicted, democrat controlled California than president Bush who let Enron screw us by manipulating our energy prices before Enron failed.

FREE Special: Subscribe to Kirk Lindstrom's Investment Newsletter and get the January 2009 issue for free (your 12-month subscription will start with the February 2009 issue).

10 Years
Kirk Lindstrom's Newsetter
2007 2008 Combined
Through 12/31/08
80% Core Aggressive + 20% Explore
6.31% (29.90%) (25.47%)
95% Core Conservative + 5% Explore (50:50 Balanced)
6.54% (17.13%) (11.72%)

Brinker Marketimer

Model Portfolio #1 - Aggressive

9.17% (39.71%) (34.18%)
Model Portfolio #2 - Moderate

9.04% (37.45%) (31.79%)
Model Portfolio #3 - Balanced

7.94% (23.86%) (17.81%)

Vanguard Index Funds

VTSMX - Wilshire 5000
5.49% (37.04%) (33.58%)
VFINX - S&P500
5.39% (37.02%) (33.62%)

(Brinker Marketimer 10-year performance includes effect of QQQ advice.)


  1. What is happening with the CA Muni bond Fund is not that much different from what is happeneing with other muni bonds. There is a "flight to quality" which has made Treasuries unusually low in yield compared to all other fixed income investments.

    Does that mean that CA Muni Bonds (or muni bonds in general) are on sale? Who knows. The credit spread (spread beween US Treasury vs. other borrowers) is wide, but that doesn't mean that interest rates as a whole don't spike when all this stimulus starts to work.

    What MOAB does exists is:
    1) Short US Treasuries;
    2) Buy high rated GO Munis (especially pre-refunded munis)

    That way, you are, more or less, insulated from interest rate risk, and you are just waiting for some normalcy to return to the spread between Treasury and Munis.

    For instance, a pre-refunded muni is almost as good as a US Treasury (from my point of view it is as good, but there are some structure risks). So, if a 5-year US Treasury is 1.70%, and the 5-year pre-refunded is 2.25%, that is an extra 0.55% of yield for virtually no more risk. On top of it, the 2.25% is not subject to federal income tax.

    Now, if you can short (borrow) the 5-year treasury for under 2.25% (all-in), and earn 2.25% on the muni, that should be a trade you do all day long, and wait for the markets to normalize.

  2. Good points. If the spread really were 0.55% net of expenses, then I would expect all the Pimco/Bill Gross superstar bond fund managers to be all over the trade and drive the spread to near zero unless they think the risk of a default is more than tiny.

  3. "If the spread really were 0.55% net of expenses, then I would expect all the Pimco/Bill Gross superstar bond fund managers to be all over the trade ..."

    The market is NOT BEING EFFICIENT. There is no reason in an efficient market that a pre-refunded Muni trades above the yield of a corresponding Treasury. All else being equal, a savy investor (foreigh or domestic) will take the higher yielding of the two. In addition, the person subject to US Income Tax will buy the muni for a higher after tax yield.

    The only efficient market rationale I could think of is: Flight to quality - There is so much "temporary" investments in US Treasuries that it distorts the yield curves. Liquidity is the only reason that could support the yield differential. People are willing to accept 0.50 % less for liqudity. There are not enough "natural" investors to buy the muni's instead. This is consistent with the observation that the Treasury Market is out of whack with the rest of the bond market.

    This "temporary" investment scenario implies a wicked boomerang when investors sell their temporary investments. The price of treasuries will crash (yields with spike).

    That is why shorting treasuries, and offseting the interest rate risk with pre-refunded munis, could be a gift horse to the well funded risk taker.

  4. California Bond Yields Rise to Four-Year High on Budget Impasse

    The nation’s most-populous state will run out of money to pay bills as soon as February unless lawmakers end an impasse over how to close the funding gap. California has the second- lowest credit ratings in the country because of perennial fiscal shortfalls and legislative gridlock.
    California general-obligation bonds maturing in 2038, with a stated interest rate of 5.25 percent, traded at 81.9 cents on the dollar to yield about 6.66 percent, according to the Municipal Securities Rulemaking Board. That’s 1.57 percentage points more than three months ago.

    ...“Until we have solved our budget crisis and until the financial community sees that we are getting our act together, there’s no confidence out there in us, and no one is going to buy our bonds,” Schwarzenegger told reporters Dec. 21 in Los Angeles.


    “Right now, Wall Street is believing that California is a place you should not invest in, and until these things get fixed investors are going to stay away,” Treasurer Bill Lockyer said.

  5. I had been in VCAIX for a while. While I like Vanguard, this fund has been underperforming others in the last 6 months, so I dumped it.

    I'm trying to find an alternative to it. Any suggestions? FCSTX has done well.

  6. My recommended bond funds for conservative investors are in The Retirement Advisor. Click to download the January 2009 free sample issue for more commentary.

  7. If you listen to brinker you will lose it all. He is a hack for the mutual fund industry and a complete idiot. Why do you people listen to this loser? If you bothered to check his track record you'd realize he is clueless.


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