Erin Arvedlund: Muni bonds can cash in on higher education

Think college tuition is going to continue to go up? One way to capitalize on the trend is by investing in municipal bonds linked to universities. That's a way to profit from the cost of a pricey higher education.

Investors worldwide are searching for income ideas and are returning to municipal bonds after the 2008 credit crisis and a default headline scare in 2011. But according to recent research by Moody's credit-rating agency, muni bonds defaulted at a significantly lower rate than corporate bonds — even through both crisis periods.

For money managers and investors, munis may be underrated compared with corporate bonds. The average cumulative default rate between 1970 and 2011 was 0.37 percent for Baa-rated munis, much lower than the 0.48 percent rate for globally ranked corporate bonds rated triple-A, Moody's said in a March report.

We checked in with Troy Willis, OppenheimerFunds senior portfolio manager, who works with a team overseeing 15 state-specific municipal-bond funds and five national municipal-bond funds. He likes Pennsylvania municipal bonds — not necessarily the recent $950 million issue by the state ("We passed on that") — but on the higher-education muni-bond sector.

"Our Oppenheimer Pennsylvania fund yields over 5 percent currently," he said in an interview. "We do all our own credit research, and we like the small triple-B-rated colleges" like Gwynedd Mercy College and Pennsylvania-owned universities like Edinboro that have issued bonds. (FYI for investors: The State System of Higher Education schools are Bloomsburg, California, Cheyney, Clarion, East Stroudsburg, Edinboro, Indiana, Kutztown, Lock Haven, Mansfield, Millersville, Shippensburg, Slippery Rock, and West Chester Universities.)

Ratings agencies tend to mess up college ratings, he said. "If the college has been around for 100 years, it's a mortgage on the campus, and that's often worth more than the [muni-bond] issue," Willis said. Moreover, private and public colleges often "don't have problems in downturns."

The ratings agencies rate Harvard a triple-A credit because it's Harvard, and Swarthmore gets a better rating because it has a big endowment. Which, he argued, means the smaller colleges are underrated: "When you rate a bond, it should be based on, what is the probability that they pay you back?"

Some of the bonds are general-obligation bonds of the university, or are linked to new dormitories.

Willis noted that Robert Morris University near Pittsburgh has had zero defaults in the last 40 years of issuing bonds. "As a result, these colleges are paying more [in interest], and we are getting a higher yield."

OppenheimerFunds holds University of Delaware paper in its national funds, as well as bonds for Fairleigh Dickinson University in New Jersey.

These fund managers also like hospital bonds built around universities such as Thomas Jefferson in Philadelphia, a city where 26 percent of employment is in health-care jobs. They even like Temple University bonds, which have for years skated on the edge of being investment-grade.

"We pay attention to tuition and enrollment. They have no problem filling seats," Willis said.

In health care, generally, the funds own hospital bonds like Geisinger Health System and the University of Pittsburgh Medical Center. The latter, one of the leading nonprofit hospital borrowers in the muni market, runs 15 hospitals in Western Pennsylvania.

Local money-management firm Cumberland Advisors agrees that even though the overall story on municipal credit has gotten better, "surveillance on individual issues has become more important than ever — in great part due to headline risk regarding pensions and other costs at local levels," the firm wrote in a recent note to clients.

Obviously, few people have the time to do research, which is why they buy mutual funds investing in muni bonds, or in exchange-traded funds. Munis are considered less liquid than Treasury or corporate bonds. Some muni bonds never trade, and most trade infrequently. Almost every mutual-fund family managing fixed income could have Pennsylvania and other state muni funds, but the fees and front-end load charges mean returns can vary widely.

There are also muni-bond ETFs holding Pennsylvania and New Jersey higher-education paper, such as the PIMCO Intermediate Municipal Bond ETF (MUNI). As of April, the annual dividend totaled just 1.65 percent. But remember that ETFs can trade at a premium or a discount to the net asset value of the holdings in the fund, so be sure to check with your broker before purchase or sale.

Erin Arvedlund is a finance reporter and resides in Philadelphia. Contact her at erinarvedlund@yahoo.com or at 646-797-0759. Read more of her columns at www.philly.com/arvedlund.