It's time somebody said a nice word about municipal bond mutual funds.

Past time, probably, considering the sad state of muni funds' affairs. In the midst of a roaring financial boom, their assets are falling, their market share is shriveling and their cash flow is going the wrong way.

Even when investors want the shield from federal income taxes that bonds sold by state and local governments offer, they don't seem eager to get it in a mutual fund package.

According to the Investment Company Institute, investors cashed out $14.5 billion more than they put into municipal bond funds in the first half of 2000, on top of a $12 billion net outflow in 1999. In the last year and a half, muni fund assets have shrunk by $28.4 billion, or almost 10 percent.

Six and a half years ago, muni funds, at $249 billion, accounted for a 16.6 percent share of the $1.5 trillion invested in long-term stock, bond and hybrid funds, as reported by the ICI. Now, at $264 billion, their share is 4.8 percent of a $5.5 trillion pot.

One strike against muni funds is simply that they're bond vehicles in a golden age for stocks. Over the past dozen years the Standard & Poor's 500 Index of stocks has returned 19 percent a year, twice the 9.5 percent annual return of the Lehman Brothers Long Treasury Bond Index.

Taxable bond funds investing in governments, corporates, and other debt securities subject to U.S. income tax are suffering outflows too.

"Right now it's tough to make a case for any bond funds," said Jeffrey Shames, chairman and chief executive of MFS Investment Management in Boston, which manages $155 billion in funds and other accounts. "At some point that will change."

Another drag has been a series of increases in short-term interest rates by the Federal Reserve since mid-1999. Not all long-term interest rates in the bond market have risen as well the yield on 30-year T-bonds, at around 5.7 percent, is actually about a half percentage point lower than it was at this time last year.

Still, given that yields available on many short-term money market funds have climbed above 6 percent, it's easy to see why investors aren't clamoring after similar or lower yields in bond funds.

That doesn't explain all the woes of bond funds, though. The fact that mutual funds, with their continuously managed portfolios, have no maturity dates doesn't sit well with many conservative investors who can choose instead to put their money directly into bonds with a known payback at a set time.

Invest in a bond fund, by contrast, and you have to take whatever market conditions dictate when you want your money back.

There's another hang-up specific to muni funds. With all the buying and selling of bonds they do, muni funds frequently realize capital gains on those transactions which they must pass along to their investors each year, taxable at capital gains rates. Muni bond interest is tax-exempt; not so these capital gains.

OK, amid hopes the Fed is about done putting the clamps on interest rates, muni fund performance has perked up lately. The Bloomberg average of 533 general muni funds shows a 4.8 percent return so far this year, including both price appreciation and dividends. That beats the 3.7 percent average return for 6,561 stock funds.

Among the 10 largest bond funds as tracked by Lipper Inc., the two best performers over the first seven months of the year were the $12.7 billion Franklin California Tax-Free Income Fund, up 6.8 percent, and the $6.3 billion Franklin Federal Tax-Free Income Fund, up 5.2 percent.

"There have been some signs of life in 2000," says Chris Kelsch, an analyst who follows muni funds at the research firm Morningstar Inc.

Chet Currier is a columnist for Bloomberg News.

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