NEW YORK, May 3 (Reuters) - Top investment firms such as Franklin Templeton and Oppenheimer have funds that still hold significant amounts of high-yielding Puerto Rican municipal bonds, despite risks inherent in the Caribbean island's economy.

Fri May 3, 2013 2:36pm EDT

By Sam Forgione
    NEW YORK, May 3 (Reuters) - Top investment firms such as
Franklin Templeton and Oppenheimer have funds that still hold
significant amounts of high-yielding Puerto Rican municipal
bonds, despite risks inherent in the Caribbean island's economy.
    The Franklin Double Tax-Free Income Fund had 66
percent of its assets invested in Puerto Rican municipal bonds
according to an April 30 analysis by Lipper, a Thomson Reuters
company. Five of Oppenheimer's Rochester muni funds had over 20
percent exposure to the debt.
    Puerto Rico, a U.S. territory, pays the highest rates of any
major tax-free borrower in the $3.7 trillion U.S. municipal
market, given fiscal challenges such as the commonwealth's large
structural budget gap, unemployment rate of 14.2 percent, and
underfunded public pension system.
    All three major credit ratings firms have recently
downgraded Puerto Rico's bond ratings to just above junk-bond
status in the wake of a six-year recession that ended in 2012.
    "Despite the credit risk, demand for yield has been pretty
strong, helping to drive prices higher on Puerto Rico's general
obligation municipal debt," said Domenic Vonella, analyst at
Municipal Market Data.
    Yields, which move inversely to prices, on Puerto Rico's
10-year general obligation municipal bonds have fallen from 5.04
percent on April 10 to 4.81 percent as of Thursday, according to
MMD data. 
    Those patently higher yields, combined with the price gains
since April, have made them more compelling to some investors
than their triple-A rated U.S. counterparts. The U.S. bonds
offer a lower yield of 1.66 percent as of Thursday, and have
seen less price gains since yielding 1.74 percent on April 10.
    While municipal debt is generally free from federal income
taxes, Puerto Rico's municipal bonds are also exempt from state
and local taxes in all 50 states on their interest payouts,
which is an added perk for investors.
    The Franklin Templeton fund, for example, has earned a
return of 2.45 percent so far this year, above the 1.56 percent
return on the Barclays Municipal Bond Index, according to
Lipper. The fund had $692 million in assets at the end of March.
    The fund's managers were not immediately available to
comment. 
    Even with those advantages, the risks of holding Puerto
Rican municipal debt may outweigh the rewards.
    "This is a good time to get out of Puerto Rico's municipal
debt," said Jeff Tjornehoj, head of Americas research at Lipper,
in light of the island's tepid economic recovery and the recent
price gains.
    The following are the top 20 mutual funds and
exchange-traded funds that invest in Puerto Rican municipal
bonds, according to Lipper: