A relative of mine recently retired from a long career as a teacher in California. In retirement they are receiving pension payments from the state teachers pension fund (CalSTRS). I am posting to get some feedback from the community on which to recommend: a broadly diversified muni bond fund, or a California focused muni bond fund.
The case for the CA state focused fund:
The bond income is tax-exempt at the state level (9.3% marginal rate) as well as at the federal level. This results in about a 0.25% increase in tax-equivalent yield over an intermediate term multi-state fund.
The case for a multi-state Muni fund:
There may be better diversification benefits than the CA fund, particularly when considering that their primary income stream is from the state pension system. My thesis is that when local municipalities file for bankruptcy they choose between paying the pension system, or paying bond holders. You are likely to lose on one of the two. This has been the case in the recent bankruptcies of Stockton, Vallejo, and San Benardino (all opting to pay the pension at the expense of bond holders). A broad based muni fund would only have 10-20% exposure to CA municipal debt.
Any feedback on which to recommend or insight on the relationship between pension security and municipal bond credit risk would be appreciated.