358 / 772
20
Gov. Alejandro Garcia Padilla of the commonwealth
of Puerto Rico warned on June
29
that the U.S. terri-
tory couldn’t pay its
$72
billion of debt. Padilla has
directed a working group to negotiate with creditors
and develop a debt-restructuring plan that would
defer debt payments by “a number of years” by the
end of August.
The commonwealth’s municipal bonds have histori-
cally been favored by a meaningful number of mutual
funds because they pay higher yields and have
“triple tax-exempt” benefits. That status means the
interest earned on Puerto Rico’s bonds is not only
shielded from federal income taxes but also state and
local income taxes, because of its status as a U.S.
territory. That fact alone had been a powerful moti-
vator for some investors to overlook the credit risks
presented by debt of the commonwealth. It had also
made these bonds attractive to some municipal-
bond fund managers who run funds invested in single-
state markets, because by prospectus many single-
state muni funds can invest in Puerto Rico’s bonds. In
addition, the
SEC
enabled single-state muni funds
to buy Puerto Rican debt in large quantities by waiving
the name rule requirement that says funds must
invest at least
80%
of assets in the asset class implied
in the fund name. If the
SEC
hadn’t done that, then
a New York muni fund would have been limited to less
than
20%
of assets in Puerto Rico.
More than
20%
of U.S. open-end bond mutual
funds—the vast majority of which are municipal and
dedicated high-yield municipal funds—collectively
own more than
$11
.
4
billion of the island’s debt, or
just over
15%
of its outstanding issuance. More
specifically, roughly
50%
of U.S. open-end municipal-
bond funds hold some exposure to debt of the
commonwealth, ranging from less than
1%
of assets
to more than
50%
of assets. The balance of Puerto
Rico’s bond obligations are largely owned by indi-
vidual investors and various hedge funds.
Noticeably absent from the list of large investors in
the island’s debt are some of the bigger players
in the municipal space. The fixed-income teams at
Fidelity, T. Rowe Price, and Vanguard have largely
steered clear of investing in Puerto Rico. None of the
23
Fidelity municipal funds had assets invested in
the commonwealth’s bonds as per the most recent
portfolio data provided to Morningstar. Several
T. Rowe Price and Vanguard municipal funds do have
some minuscule exposure to Puerto Rico.
OppenheimerFunds and Franklin Templeton Invest-
ments are two of the largest holders of the common-
wealth’s debt with some of the largest concen-
trations in single-state funds. The Oppenheimer funds
hold some of the heaviest weightings to the
commonwealth’s debt. Based on the latest portfolio
data provided to Morningstar,
19
of the
20
Oppen-
heimer Rochester funds had some exposure to Puerto
Rico, and
17
had weightings in the double digits
ranging from just over
10%
of assets to nearly
50%
of assets. Allocations in the Franklin funds, while
still meaningful, tended to be much smaller. Of the
32
funds in the Franklin municipal-fund complex,
26
funds listed some exposure to Puerto Rico’s bonds in
their most recent portfolios provided to Morningstar;
12
funds had exposures of between roughly
4%
and
7%
of assets. The exception here is the closed
Franklin Double Tax-Free Income
FPRTX
, which
holds over
50%
of assets in Puerto Rican debt as of
June
30
. In contrast, the largest national muni
funds had small weightings to Puerto Rican debt,
usually less than
2%
of assets.
Currently, none of the above-mentioned Oppenheimer-
Funds funds or Franklin funds with more than a
5%
allocation to Puerto Rico are included in the
Morningstar
500
list nor do they carry a Morningstar
Analyst Rating. The two Franklin funds that are
featured on the list in July,
Franklin Federal Tax-
Free Income
FKTIX
and
Franklin High Yield
Tax-Free Income
FRHIX
, currently list weights of
less than
4%
to Puerto Rico’s bonds.
K
Contact Elizabeth Foos at
elizabeth.foos@morningstar.comPuerto Rico’s Back in the Hot Seat
Income Strategist
|
Elizabeth Foos