Puerto Rico might be a nice place to visit, but I wouldn’t want to invest there. If you think it might be a good idea to diversify and include some high yield junk bonds in your portfolio, Puerto Rico’s governor might give you reason to think again. In June 2014, Puerto Rican Gov. Alejandro Garcia Padilla signed a bill into law allowing the restructuring of $19 billion of revenue bonds issued by commonwealth-owned electricity, water and highway monopolies.
You might have thought that debt secured by a particular stream of revenue might be safer than general obligation debt, but in this situation, you would be mistaken. When there is systematic failure of customers to pay their bills – in this case customers of large government entities – there is little likelihood that funds will be found to pay the debt. The new law, according to Moody’s, “provides a clear path to default for Puerto Rican public corporations.”
You may have thought you could diversify your risk by purchasing a high yielding mutual fund without looking inside the box. However, there is a lesson here for Muni bond investors. Oppenheimer and Franklin Templeton Funds hold $1.7 billion of the electric company bonds, known as Prepa.