Your Money: Note of caution on Puerto Rico muni bonds

Attention, municipal bond investors. You may love tax-free bonds, but Cumberland Advisors, of Vineland, N.J., is veering away from the troubled muni bonds of Puerto Rico - even though some in the hedge-fund community are embracing this high-risk trade.

"We certainly hope that the Commonwealth of Puerto Rico finds a way to avoid any defaults. We are not cheering for the demise of this beautiful island," Cumberland noted.

But 45 percent of its 3.5 million inhabitants live below the poverty line, Cumberland said, and the debt-to-gross-national-product ratio is estimated at 140 percent, if the pension liability is included.

Cumberland's chief investment officer, David Kotok, says his firm does not own Puerto Rico bonds for clients, arguing there is additional risk of trouble in paradise: risk of a debt-service payment problem in the event that Puerto Rico finds itself with insufficient cash flow, and risk if the commonwealth fails to obtain sufficient market access so that it can refinance its debt.

"At Cumberland, we are not holding Puerto Rico debt - we do not own it, and we would not buy it today," Kotok said in a strongly worded note to investors. "The same is true for any mutual fund with exposure to Puerto Rico."

Maury Fertig, chief investment officer at Relative Value Partners, trades in closed-end funds, a quirky part of the market in which the funds can trade at a discount to their value. That's a buying opportunity, until the fund's price closes that gap.

Closed-end funds sometimes trade under 100 percent of their value, say, at 90 cents on the dollar, equal to a 10 percent discount. Investors make money by buying when the fund trades at that discount and waiting for the price to come back to full value.

Fertig is located in Chicago, but we thought his data and ideas are informative. He expects numerous closed-end funds to trade at discounts through the end of the year, specifically fixed-income closed-end funds. He highlights the following:

MFS Charter Income Trust (NYSE: MCR). This fund owns mortgages, corporate bonds, and Treasuries, and trades at a discount of 12 percent.

Putnam Premier Income Trust (NYSE: PPT). This is a "short-duration" fund, meaning bonds that don't have as much sensitivity to interest rates. Putnam Premier Income Trust currently trades at a discount of 12.13 percent.

BlackRock Credit Allocation Income Trust (NYSE: BTZ). This fund trades at a multiyear discount of nearly 15 percent.