New Choices, Higher Yields in Muni Funds

Over the past year, fund companies have rolled out exchange-traded funds that give investors low-cost access to municipal bonds. At the same time, the credit crunch has weighed on these bonds, making them a good buy, financial advisers say.

Municipal bonds are typically issued by state or local governments and are often free of federal, state and local income tax. Due to their tax advantages, muni bonds usually yield less than comparable Treasury bonds. But the subprime meltdown and credit crisis have dragged down these bonds, partly because some companies that insure mortgages also insure munis.

At the same time, safety-seeking investors have flocked to Treasury bonds, driving their prices up and yields down. (Bond prices and yields move in opposite directions.) The result: Many muni bonds now yield as much as or more than comparable Treasurys.

Investors interested in muni bonds have a slew of new fund choices. Barclays Global Investors last September launched the first muni-bond ETF for U.S. investors, the iShares S&P National Municipal Bond Fund (MUB). That was quickly followed by competitors like PowerShares Insured National Municipal Bond Portfolio (PZA) and SPDR Lehman Municipal Bond (TFI).

Van Eck Global has launched a lineup of "AMT-free" muni-bond ETFs, which avoid bonds that are subject to the alternative minimum tax. An ETF resembles a conventional mutual fund but trades on an exchange like a stock.

A key advantage of these new funds is their low costs. In traditional muni-bond mutual funds, expenses can eat up much of the funds' typically modest returns.

The average muni-bond mutual fund charges annual expenses of 1.01% of assets, according to investment research firm Morningstar. But the iShares ETF charges just 0.25%, while the SPDR fund charges 0.2%.

That doesn't mean ETFs are always the cheapest choice. The Investor shares of Vanguard's Long-Term Tax-Exempt mutual fund, for example, charge 0.15%.

Online calculators can help you determine if muni bonds are right for you. Using a tool at investinginbonds.com (click on "Calculators"), you can enter your state of residence, net taxable income and tax-filing status, and see the yield you need to earn on a taxable security in order to match the tax-free yield of a muni bond.

If you believe tax rates are going up, you have another reason to consider muni bonds. "Assuming higher federal tax rates, that will give you some kind of cushion in your munis. They'll be worth more, not less," says Marilyn Cohen, chief executive officer of Los Angeles fixed-income money management firm Envision Capital Management.

Write to Eleanor Laise at eleanor.laise@wsj.com