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Nearly one year since Puerto Rico Governor Alejandro
Garcia Padilla stated that the U.S. territory couldn’t
pay its
$72
billion in debt, little has changed. Although
an initial debt payment was made directly after the
governor’s
2015
announcement, various agencies have
missed debt payments since then. Most recently,
the Puerto Rico Government Development Bank, the
main fiscal manager for the island’s debt, missed
a roughly
$400
million debt payment due May
1
. The
commonwealth may also miss a
$2
billion debt
service payment due on July
1
, nearly half of which is
secured by Puerto Rico’s general obligation pledge.
As we’ve noted before, the commonwealth’s munic-
ipal bonds have been held by a number of mutual
funds because they pay higher yields and have “triple
tax-exempt” benefits. That means the interest
earned on Puerto Rico’s bonds is spared from federal,
state, and local income taxes, which made them
popular investments for some single-state muni funds.
And because the names of the funds don’t suggest
the presence of such holdings, many investors might
not realize how much of this distressed debt is in
their portfolios.
According to Morningstar’s data, nearly
50%
of U.S.
open-end muni-bond funds hold some exposure
to Puerto Rico bonds, ranging from less than
1%
of
assets to more than
50%
. The balance of these
obligations is largely owned by individuals and hedge
funds. Many insurance firms and pension funds
can’t hold the commonwealth’s debts because of its
below-investment-grade-ratings, which the major
credit-rating agencies assigned beginning in
2014
.
Absent from the list of the island’s investors are
some of the largest stewards of capital in the muni
market—including most of those with muni-bond
funds listed in the Morningstar
500
. For example, the
muni teams at Fidelity, T. Rowe Price, and Vanguard
continue to avoid meaningful concentrations in Puerto
Rico debt with their current portfolios. Of Fidelity’s
22
muni funds, six of which carry a Morningstar Analyst
Rating of Gold, none had assets invested in the
island’s bonds per their most recent portfolios. Several
T. Rowe Price and Vanguard funds have some
exposure to Puerto Rico, yet the stakes are modest,
with most funds holding less than
1%
of assets in
the island’s debt.
OppenheimerFunds and Franklin Templeton Invest-
ments remain two of the largest holders of the
commonwealth’s debt, with Oppenheimer holding
some of the heaviest weightings in its single-state
muni funds. Based on the latest portfolio data avail-
able,
19
of the
20
Oppenheimer Rochester funds
had exposure to Puerto Rico, and
16
had weightings
ranging from
10%
of assets to nearly
50%
. Alloca-
tions in the Franklin funds are much smaller.
As of March
31
,
2016
, of
32
Franklin muni funds,
24
listed exposure to Puerto Rico bonds ranging from less
than
0
.
3%
of assets to
4
.
0%
. The exception was
Franklin Double Tax-Free Income, which held nearly
50%
of assets in Puerto Rico debt as of the end of
March
2016
. The fund experienced net outflows and
was reorganized into the firm’s
$8
billion
Franklin
High Yield Tax-Free Income
FRHIX
as of April
29
,
2016
. According to Morningstar data, Franklin Double
Tax-Free Income held less than
$145
million in assets
at the time of transition and was expected to bring the
concentration of Puerto Rico debt in Franklin High
Yield Tax-Free Income up from roughly
3%
of assets
to
3
.
9%
.
The two Franklin funds in the Morningstar
500
,
Franklin Federal Tax-Free Income
FKTIX
and
Franklin High Yield Tax-Free Income, currently list
modest weightings of the island’s debt.
K
Contact Elizabeth Foos at
elizabeth.foos@morningstar.comFunds Grapple With Exposure to
Puerto Rico
Income Strategist
|
Elizabeth Foos