The high yield municipal bond market is attracting an increasing number of investors who are focused on income-oriented investments and the tax benefits of municipal bonds. But buying individual high yield muni bonds is probably not the best option for most investors because the characteristics of each high yield muni bond can vary and a large number of issues are not rated by credit ratings agencies.¹ Instead, mutual funds, which employ credit analysis and bond selection skills of professional managers, can offer investors the numerous potential benefits of the high yield municipal market.

The Benefits of High Yield Municipal Bonds
There are multiple benefits to investing in high yield municipal bonds, including the potential for attractive after-tax income and price appreciation. Additionally, high yield munis have historically had relatively low default rates versus similarly rated high yield corporate bonds and a low correlation with other asset classes.²

• After-Tax Income: Like most municipal bonds, coupon payments on high yield munis are exempt from federal taxes, and in some cases, state taxes. This can lighten the overall tax burden for individuals and tax-paying institutions, particularly when their taxable income falls within the upper portions of the federal marginal tax rate scale. Investors should always weigh the relative value of municipal bond investments against similar taxable investments and their individual tax situation, but in many cases the tax advantages offered by high-yield munis can offer enhanced value.
• Relatively Low Default Rates:  Historically, default rates on high yield municipal bonds have been far lower than for similarly rated corporate bonds. The high yield muni sector typically finances projects with relatively stable revenue streams, such as taxes, fees, and tolls. Additionally, projects financed by high yield munis are often hard assets that act as collateral for bond holders, and recovery rates are also high relative to high yield corporate bonds. A study by Moody’s Investors Service found that over the period from 1970 to 2000, the average cumulative default rate for speculative-grade munis was 1.93%, compared to a 32.04% cumulative default rate for speculative-grade corporate debt.
• Diversification: High yield municipal bonds have relatively low correlations with stocks, bonds, and other assets.² The High Yield Municipal Bond Fund can be an excellent tool for investors looking to diversify their risks. That contrasts with high yield corporate debt, for example, which finances speculative growth in businesses and can be influenced by the same factors that influence equity prices. In the 10 years ending March 2006, monthly returns for high yield munis had a very low 16% correlation with the S&P 500, while high yield corporate bonds had a much higher correlation of near 50%.
• Price Appreciation Potential: PIMCO is running the High Yield Municipal Bond Fund as a total return vehicle, which means we are always looking for opportunities to purchase bonds with the potential for price appreciation. In some cases, the focus might be on bond issuers likely to see an improvement in credit quality. In other cases, we might look for the likelihood that the security will outperform the market amid shifts such as movements in prevailing interest rates or downturns in corporate bond markets. It is important to note that capital gains from trading high yield municipal bonds might be subject to federal taxes.

Focus on Enhanced Returns
PIMCO’s High Yield Municipal Bond Fund aims to provide a high level of income that is exempt from federal income tax, and to seek opportunities for capital appreciation. We plan to achieve these two goals by taking a conservative stance on risk, with a heavy emphasis on credit analysis and on identifying sectors and credits where we see the potential for price appreciation.

With 30 years of experience as a fixed income specialist firm, PIMCO is well positioned to take advantage of opportunities in the high yield municipal bond market. As we do with all municipal bonds, our approach is to employ a top-down secular view of the economy combined with the bottom-up analysis on specific projects, bond structures, interest rate sensitivity and credit quality. For high yield municipal bonds, this stringent approach is especially important since about 54% of high yield muni issuance is not rated.¹ This puts a high burden of due diligence and credit analysis on the investor in exchange for higher potential returns.

High yield municipal bonds are a rapidly growing portion of the broader municipal market and made up approximately 4.2% of the Lehman Brothers Municipal Bond Index as of June 2006. The bonds are mostly issued to finance economic or industrial development, housing, healthcare and environmental projects. The debt is typically issued by a government unit, which then lends the money to a non-profit borrower under section 501(c)(3) of the federal tax code. Interest payments are usually supported by a special tax or revenue from the project, and the bonds are often backed by the hard assets or mortgages associated with the project.

Conclusion
PIMCO High Yield Municipal Bond Fund offers the multiple potential benefits of the high yield muni market, and provides the expertise and rigorous analysis and security-selection techniques that PIMCO has developed in the fixed income markets. With a focus on credit quality, after-tax income, the potential for price appreciation and PIMCO’s reach in the markets, the High Yield Municipal Bond Fund can give investors access to this important sector while avoiding the challenge of investing in individual securities.