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Municipal Bonds Safe, But Coasts Are Rocky

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Despite all the headlines about budget deficits and missed bond payments, the states -- and their municipal bonds -- remain safe to invest in, says Robert DiMella, portfolio manager for the MainStay Tax-Free Bond Fund.

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The $354 million fund is up 7% over the past year, better than 80% of its Morningstar peers. Over the past five years, the fund has returned nearly 4% annually, putting it into Morningstar's 64th percentile for national municipal bond funds.

Welcome to TheStreet.com's Fund Manager Five Spot, where America's top mutual fund managers give their best stock picks and views on the market in a five-question format.

Are the states safe to invest in?

DiMella: They are safe. There is a lot of fear out there with what's going on with municipalities and their credit. But at the state level, the states are safe. There are some pockets which you need to avoid, but the states will not default.

Which states are the best to invest in right now? Which ones are the safest?

DiMella: The safest are those states that weathered the economic downturn very well. Texas, for example, has very prudent financials. The balance sheet has come under a little bit of pressure recently, but it's still a very solid state. It's the coastal states that tend to be the weakest, states like California and New York. And Illinois is probably the worst, structurally and financially speaking.

What are the long-term effects of what is going on in Harrisburg, Pa.? The capital of Pennsylvania is having problems paying its municipal debts. What does this mean for the rest of the country?

DiMella: That case sheds a lot of light about what is going to happen in the municipal marketplace. For instance, they had the money to pay that last payment but they just wanted to force the state to get involved so they could go into receivership, or Act 47. This enabled the state to come in and help them with their finances, which really means going after their overall spending and size of government, instead of the politicians themselves doing it and risking not getting reelected.

In states where there is a problem paying off their debts, will the government come in and save them?

DiMella: The federal government cannot come in and guarantee municipal debt. It's a federalist society, so they can't do that. But they can institute many different measures to help the municipal marketplace out. You saw it in the stimulus plan last year under the American Recovery and Reinvestment Act. That brought about the Build-America Bond program that helped the absolute level of funding for the municipal marketplace. You also saw a lot of funding to help different projects that alleviated a lot of stress in the municipal marketplace. So there is a lot of things the government can do and will do. The current administration and Congress is very pro-municipal marketplace in order to support them and manage them through this financial crisis.

Are revenue bonds better than G.O.'s, considering the circumstances in the states right now?

DiMella: They are, and this is the reason why we have been overweight revenue backed bonds coming into 2010. They are showing a lower level of volatility, and you have dedicated revenue streams backing these bonds. Therefore you can ride out the uncertainty and risk that's in the marketplace today. That bodes very well for clients.

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