Just as in the taxable bond market, the highest-yielding municipals in any given maturity range typically involve higher credit risk the risk that the issuer may not make all required interest and principal payments on the bond. Investors should carefully weigh this trade-off in seeking high yields and should make sure they are compensated for assuming the additional risk. If the higher yield appears to reflect the higher risk adequately, investors can minimize the risk of owning one or a few bonds by seeking the broad diversification and active management of a mutual fund. Before discussing some approaches to investing in this market, it's a good idea to become familiar with its basic characteristics. Unlike the taxable market, a majority of high-yield municipals are not rated by major rating agencies.
Exceptions are usually bonds that have been downgraded from their original investment-grade status.
Since there are thousands of relatively small issuers, each with a distinct financial profile often dependent on a particular local government, economy, or project, the high-yield market is fragmented and localized. Mutual funds dominate demand for these bonds. Given the widespread lack of ratings and the intensive research required to assess the credit quality of each issuer, it is not surprising that most individuals who wish to buy high-yield municipals do so through mutual funds in order to diversify their portfolios. It varies according to market conditions. This contraction reflected strong demand from investors seeking attractive yields in a falling interest rate environment.