PUTNAM I NVESTMENTS|putnam.

com
Theclassicstrategicreasonstoownmunicipalbondsstillholdtrue:Theygenerally
havelowcorrelationstootherassetclassesandoferameaningfultaxadvantage
toinvestorsfeaturesthatareunlikelytochangeinthenearterm.However,the
municipalbondmarkethasexperiencedasignifcantshiftoverthepastseveralyears
throughthevirtualdemiseofmunicipalbondinsuranceandthestressofhighly
constrainedfederalandstatebudgets.Thispaperwillexaminehowthesechangesin
themunicipalbondmarkethavehadanimpactontheevaluationofmunicipalsecuri-
ties,whetheritmakessensetoinvestinmunicipalbondstoday,andhowinvestors
mightneedtochangethewaytheyimplementtheirinvestmentstrategiesasaresult.
Figure 1. Municipal bonds are not highly correlated with other asset classes
Municipal bond correlations versus other assets (1/31/9212/31/11)
0.03
0.09
0.30
0.59
0.69
AA U.S. corporate bonds
10-year U.S. Treasuries
U.S. high-yield bonds
S&P 500 Index
1- to 3-month T-bills

Sources:BarclaysCapitalBondindices,Standard&Poors.
Stacking up yesterday versus today
Incomparingthemunicipalbondmarketfrom10yearsagowithtodaysmarket,
manycharacteristicsremainconsistent.Adecadeago,thetopfvestateissuerswere
California,Florida,Illinois,NewYork,andTexasandrepresentedroughly50%ofthe
market;thisisstilltruetoday.Infact,nineofthetoptenissuersfrom2001werestillon
thatlistin2011,andcontinuedtoconstituteapproximately65%ofthemarket.
Amongthechangeshasbeenageneraltrendawayfromlocalgeneralobligationissu-
ancetowardissuesbackedbyspecialtaxesorassessments.Inmanyinstances,the
issuanceofgeneralobligationdebtrequiresvoterapproval.Onewaytoavoidgoing
throughthatprocessistoissuespecialtax/assessmentdebt,whichmayrequireno
Municipal bonds remain
strategically important
investments with signifcant
tax advantages and generally
low correlations to other
asset classes over time.
The near elimination of bond
insurance has dramatically
changed the municipal
ratings landscape.
Municipal bond fundamentals
are helped today by low
defaults and attractive
spreads over Treasuries.
Actively managed funds
driven by fundamental
research can help add
broad diversifcation and
mitigate risk.
K
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February 2012Putnam Perspective
Evolving municipal bond
market makes compelling
case for active management
Thalia Meehan, CFA
Portfolio Manager
Paul M. Drury, CFA
Portfolio Manager
Susan A. McCormack, CFA
Portfolio Manager
PUTNAM I NVESTMENTS|putnam.com 2
FEBRUARY 2012|Evolving municipal bond market makes compelling case for active management
voteoravotebyamorelimitedgroupoftaxpayers.This
shiftcouldalsobeconsideredanindicationofinvestor
preferenceforcleanfowsthatothergovernmental
entitiesarenotallowedtoaccess,aswellasgenerally
reliablecovenantssupportedbyruleoflaw.
Figure 3. An increase in issues backed by
special taxes/assessments refects a tougher
budgetary environment
Distribution of municipal sectors
Sector distribution (%) 12/31/01 12/31/11 Change
State general obligation 15 17 +2
Transportation 16 15 -1
Local general obligation 20 13 -7
Special tax 3 11 +8
Water & sewer 8 9 +1
Hospital 9 9 -
Leasing 5 8 +3
Education 5 7 +2
Power 10 7 -3
Other (< 3%) 9 5 -4
100 100
Source:BarclaysCapitalMunicipalBondIndex.
However,thekeyshiftinthemarkethasbeenthe
considerablechangeincreditqualitydistribution.
AsofDecember31,2001,theAAAsegmentofthe
municipalbondmarketrepresentedapproximately
60%ofthemarket;thatfgurehasdeclinedtoonly13%
today(Figure4) !
1
Thismajorchangecanbeattributed
totwofactors:mostimportant,thenearelimination
ofbondinsuranceforthemunicipalmarket,butalso
thedownwardmigrationofmunicipalratingsinthe
wakeofsignifcantfscalstressatboththefederaland
statelevels.Atitspeakoverthepast10years,bond
insurancewasusedin57%ofmunicipalsecurities
issuedin2005,withthebulkoftheunderlyingsecurities
carryinginsuranceratedsingleA.(Asseeninthe
2001creditqualitychartofFigure4,ifbondinsurance
hadbeenstrippedout,themunicipalbonduniverse
wouldhavehadasignifcantlyhigherconcentrationof
A-ratedsecurities,ratherthanaAAA-ratedsegment
representingmorethan50%ofthemarket.)
In2011,usageofbondinsurancedeclinedtoamere5%
(Figure5).Thisprecipitousdropinbondinsurancebegan
in2008astheinsurersexperiencedmountinglosses
associatedwithguaranteesonsubprimemortgage-
backeddebt.Asaresult,insurersweredowngradedand
losttheirtopratingsorenteredbankruptcy.Withoutthe
abilitytoachieveatopratingandthereforelowertheir
debtcosts,mostmunicipalbondissuerslosttheincen-
tivetopayfortheadditionalcreditenhancement.
Thedeclineofinsuranceisonlyoneofthefactors
contributingtothedownwardtrendincreditquality.
MoodysInvestorsServicereportedthedowngrade-
to-upgraderatioforthethirdquarterof2011at
approximately5.3to1.Thisisthehighestratiosincethe
1 BarclaysCapital,BarclaysCapitalMunicipalBondIndex.
Figure 2. The top nine issuing states and Puerto Rico have remained consistent
By market value ($M)
0
50,000
100,000
150,000
200,000
12/31/11 12/31/01
Washington Pennsylvania Puerto Rico New Jersey Massachusetts Illinois Florida Texas New York California
Source:BarclaysCapitalMunicipalBondIndex.
PUTNAM I NVESTMENTS|putnam.com 3
FEBRUARY 2012|Evolving municipal bond market makes compelling case for active management
beginningofthefnancialcrisisin2008;however,the
absolutenumberofdowngradesinthethirdquarter
(163)waslessthanthepeakexperiencedinthefourth
quarterof2010(197).Whiledowngradesmaybehigh
byhistoricalstandards,keepinmindthattheyrepre-
sentasmallportionoftheMoodys-ratedpublicfnance
universeinthethirdquarter:lessthan1%(Figure6).
2

2 MoodysInvestorsService,U.S. Public Finance: Third Quarter Sets

New Peak for Ratio of Downgrades to Upgrades,November1,2011.
Value to be found
Giventhesestructuralchanges,investorsmaybe
wonderingwhethermunicipalbondscontinuetowarrant
anallocation.Webelievemunicipalbondinvestmentsare
potentiallyquiteattractive:Defaultshaveremainedlow,
contrarytooverblownpredictionsinthemedia;spreads
areattractiveonahistoricalbasis;andmuni/Treasury
ratiosarestillabovehistoricalaverages.
Defaultsinthemunicipalbondmarketaregenerally
misunderstood.Whiledefaultsdohappen,theyoccur
withfarlessfrequencythaninthecorporatebond
Figure 4. The decline of bond insurance has sharply reduced the availability of AAA bonds
Credit quality composition
12/31/01 12/31/11
BBB
A
AA
AAA

Source:BarclaysCapitalMunicipalBondIndex.
Figure 5. Bond insurance as a percentage of total municipal new issuance

0
10
20
30
40
50
60%
2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001
Source:The Bond Buyer,2011.
PUTNAM I NVESTMENTS|putnam.com 4
FEBRUARY 2012|Evolving municipal bond market makes compelling case for active management
market,andmoreoftenthannot,theyareconfnedto
particularsectorsofthemarket,typicallyinlanddevel-
opmentdealsorunratedsecurities.Webelievebond
insurancehadverylittleimpactonhistoricaldefault
statistics;theinsurersgenerallyprovidedcreditenhance-
mentforsingle-Adealsandnotforthoseatthelowend
oftheratingspectrum,whicharemorepronetodefault.
Whendefaultsoccur,theytendtocaptureheadlines.
Recently,AmericanAirliness$3.2billioninmunicipaldebt
aswellasapproximately$15billionintobaccosettlement-
backeddebtwereaddedtodefaultstatisticsalthough
nopaymentshavebeenmissed;thesedefaultswere
duetotheparticularsofthecalculationmethodology
thathasbeenusedformanyyearsbytheDistressed Debt
Securities Newsletter.Themethodologyincludestech-
nicaldefaultsaswellasbankruptciesandotherformsof
non-monetarydefault,e.g.,accessingreservefunds,asis
beingdoneinthecaseofthetobaccobonds.
JefersonCounty,Alabamaanotherheadline-grabbing
defaultin2011hadbeeninnegotiationsforseveral
yearstryingtoworkthroughitsfscalissues;however,the
countyrecentlyoptedtofleforbankruptcyandbecame
thelargestmunicipalbankruptcyinU.S.historyat$4
billion.Thecountysgeneralobligationdebtofabout$1
billionwasalsorecentlyaddedtothedefaultstatistics.
Whilemunicipaldefaultshavetickeduprecently,itis
importanttonotethatthepredictedmassivenumber
ofdefaultshasnotmaterialized.Nearlyoneyearago,
onewell-knownanalystpredicted50to100sizeable
defaults,totalinghundredsofbillionsofdollars.Those
fearsareprovingtobeunfounded.Infact,munidefaults
areonlyminimallyhigherthantheir20-yearpeakin
1991andareoutpacedhistoricallyateveryratinglevel
bycorporatebonddefaults(Figure7).
3
Thisisnottosay
thattherewillnotbefuturedefaultsinthemunicipal
market;therewillbe.Butthefundamentalbudgetstress
attheheartofthecurrentstruggleswillslowlyeaseas
thefscalmeasuresbeingputintoactionbythestates
andmunicipalitiesbegintotakeefectandastheU.S.
economycontinuestoimprove.
3 MoodysInvestorsService,U.S. Municipal Bond Defaults and
Recoveries, 1970-2009, February2010.
Muni defaults are only minimally higher than their 20-year peak
in 1991 and are outpaced historically at every rating level by
corporate bond defaults.
Figure 6. Despite the recent uptick, defaults are low as a percentage of the total market
Municipal defaults since 1990
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990
Sources:Distressed Debt Securities Newsletter,Putnam,asof11/21/11.Municipalmarketisestimatedat$3.7trillion.
PUTNAM I NVESTMENTS|putnam.com 5
FEBRUARY 2012|Evolving municipal bond market makes compelling case for active management
Figure 7. At every credit rating, corporate defaults
outpace those in the muni market
Moodys 5-year average cumulative default rates
Rating Municipal Corporate
All rated 0.05% 7.14%
Aa 0.01 0.23
A 0.01 0.72
Baa 0.08 1.93
Ba 1.57 10.40
B 11.73 25.90
Investment grade 0.03 0.97
Speculative grade 3.43 21.36
Source:MoodysInvestorsService,U.S. Municipal Bond Defaults and
Recoveries, 1970-2009, February2010.
Itisworthnotingthatrecoveriesinthemunicipalmarket
alsorunhigherthanistypicalinthecorporatecredit
market,thoughtherangeisquitewide.FortheMoodys-
rateddefaultsoccurringfrom1970to2009,theaverage
recoveryratewasapproximately67%,whiletherange
wasanywherefrombelow5%to100%.
4
Forexample,
the1994OrangeCounty,Californiabankruptcywasthe
largestmunicipalbankruptcyinhistoryatthattime,but
whatfewinvestorsrecallisthatallprincipalandinterest
paymentsweremade.Comparethiswiththeaverage
corporaterecoveryrateof41%from1982to2009.
5
That
isroughlya25%diference;recoveringaquartermorein
valueisquitemeaningful.
4 MoodysInvestorsService,U.S. Municipal Bond Defaults and
Recoveries, 1970-2009, February2010.
5 MoodysInvestorsService,Corporate Default and Recovery Rates,
1920-2009, February2010.
Withthatbackdropinmind,spreadsoncredittiers
belowAAAlookattractivecomparedwiththeirhistorical
averages.Thepresenceofbondinsuranceprimarily
infuencedtheAAAcreditsector,sofocusingonAA
andbelowisabettermeasureofhistoricalspreadlevels.
Currentspreadsrangefrom20basispointstoover100
basispointsforsecuritiesratedAAtoBBBversustheir
historicalaveragesoverthepast13years(Figure8).
6

IfthevolatiletimeperiodofOctober2008through
December2011isexcluded,thecomparisonofcurrent
spreadstoanormalizedtimeperiod(January30,1998,
toSeptember30,2008)illustratesthattodaysspreads
are50(AA)to150(BBB)basispointswiderthanwould
typicallybeexpected.Withspreadswiderthanhistorical
levelsanddefaultsremaininglow,theinvestorisgetting
paidmorethanaverageforrisksthataregenerallyinline
withhistoricalnorms.
Anothermeasureoftheattractivenessofmunicipal
securitiesisthecomparisonwithU.S.Treasurysecuri-
ties,generallyreferredtoasthemuni/Treasuryratio.
Typically,theAAA-ratedmunicipalyieldiscompared
withtheyieldofasimilardurationU.S.Treasurysecurity.
Currentmuni/Treasuryratiosfor5-,10-,and30-year
maturitiesareatlevelsapproximatelyonestandard
deviationawayfromtheirlong-termaverages.Inpart,
thisistheresultoftheabsolutelowlevelofratesaswell
asthegenerallywiderspreadlevelsofmunicipalbonds.
Buttheresultsaresignifcant:Simplystated,investors
areabletobuy30-yearAAAmunicipalsecuritiesthat
out-yielda30-yearU.S.Treasurybondonapretaxbasis.
Aftertaxes,investorsfurtherbeneftfromthetax-free
incomeoferedbymunicipalbonds.
6 PutnamInvestments.
With spreads wider than historical levels and defaults remaining low, the
investor is getting paid more than average for risks that are generally in
line with historical norms.
PUTNAM I NVESTMENTS|putnam.com 6
FEBRUARY 2012|Evolving municipal bond market makes compelling case for active management
Figure 8. Spreads remain elevated at higher credit ratings
Historical municipal spreads (bps), 1/30/991/17/12
0
100
200
300
400
500
BBB
A
AA
!999 2000 200! 2002 2003 2004 2005 2006 2007 2008 2009 20!0 20!! 20!2
Source:PutnamInvestments,asof1/17/12.
Implementing an investment strategy
Tosummarizethemunicipalbondlandscape:
Creditfundamentalsareweatheringthestormmuch
betterthananticipated
Defaultsremainlow
Creditspreadsandmuni/Treasuryratiosareattractive
relativetohistoricallevels
Researchandactivemanagementareevenmoreimpor-
tantafterthevirtualdisappearanceofbondinsurance
Butwhatisthebestwaytoimplementamunicipalbond
strategygiventhechangesinthemarketplaceandthe
currentenvironment?Aportfolioofladderedindividual
bondsorsharesofamutualfund?Investmentgradeor
highyield?Nationalorstate-specifc?Thereareseveral
waystoimplementamunicipalstrategy,andtheprimary
considerationmustalwayshingeonwhatissuitablefor
theindividualinvestor.Assumingthatrisktolerance,time
horizon,etc.,isdetermined,oneormoreofthemethodsof
implementingamunicipalstrategymaybeappropriate.
Inmanycases,amunicipalbondinvestmentstrategy
willconsistofaconcentratednumberofindividual
bondsladderedbymaturitydate.Withoutbeingableto
relyonbondinsurancetoprovideaguaranteeofprin-
cipalandinterestpayments,theresearchandreview
ofanissuerandtheprovisionsofthesecurityaremore
importantthaneverbefore.Thereareapproximately
50,000issuersinthemunicipalmarket,andtheyarefar
fromuniform,witheachhavingitsownspecifcnuances
relatingtothebondcovenantsorsomeaspectofthat
particularbondstructure.Unfortunately,manyadvisors
andinvestorsmaynotbeawareofthebestwaytofnd
thenecessaryinformationonthebondormaynothave
thetimeorexpertisetodothethoroughreviewneeded
toavoidpotentialpitfalls.Relyingonrating-agency
designationsprovidessomerelativesenseofquality,
butthatfrststepisnotasoundcreditstrategyinandof
itselfand,webelieve,isnotanoptimalwaytoavoidthe
potentiallylargelossesaninvestorcouldfaceinaport-
foliowithonlyafewindividualbondholdings.
Investinginfundsisagoodwaytoleveragevastly
greaterdiversifcationbeneftsaswellasprofes-
sionalfundmanagementcoupledwiththeexpertise
ofaseasonedresearchteam.Fundamentalresearch,
whenproperlyimplemented,canhelpmitigaterisk
byidentifyingpotentiallydeterioratingcreditsinthe
municipalbondmarket,whichmayeitherbesoldfrom
theportfoliooravoidedaltogether.Thiscapacityisof
heightenedimportancetodaywiththefarlesspromi-
nentroleofbondinsuranceandissuerscontinuingto
worktheirwaythroughthefnancialcrisis.
PUTNAM I NVESTMENTS|putnam.com 7
FEBRUARY 2012|Evolving municipal bond market makes compelling case for active management
Anactivelymanagedfundalsoprovidesavehiclethat
maytradeopportunistically,typicallyatlowercostsdue
tomoreefcientblocktrading.Moreover,themanager
mayemploystrategiessuchassectororqualityrota-
tion,andmorefexibleyieldcurvepositioning,bothof
whicharedifcultifnotimpossibleforinvestorsbuilding
theirownladderedportfolios.Additionally,investors
areabletoredeemaportionoralloftheirinvestmentat
anytime,whileindividualbondscanbedifculttoliqui-
date.
7
Fundsalsotypicallypayregular,monthlyincome,
althoughthatincometypicallyfuctuatesandisnotfxed.
Thatbeingsaid,afundisamoretransparentvehicle,
withmarketmovesrefectedinthecalculationofnet
assetvalueonadailybasis.Lastly,itisworthnotingthat
feesmaypotentiallybehigherinamutualfundthanina
ladderedportfolioduetogreateradministrationcosts.
Giventhemanybeneftsofusingamutualfundtoaccess
themunicipalbondmarket,investorsusingaportfolio
ofladderedbondsmayconsideraddingafundasa
complementtotheirexistingholdings.Forexample,
iftheinvestorownsprimarilyAA-ratedbonds,itmay
makesensetoinvesttheproceedsofthenextmaturing
individualbondintoatax-freehigh-yieldfund,which
couldpotentiallyaddqualitydiversifcationaswellas
increasedyield.Alternatively,theinvestormayown
severalstate-specifcbonds.Addinganinvestmentina
7 Shareprice,principalvalue,andreturnwillvary,andtheremaybe
againoralosswhensharesaresold.Inaddition,reviewthefund
prospectusascertainfundsmayenforceshort-termtradingpolicies.
nationalmunicipalbondfundcandramaticallybroaden
theinvestorsdiversifcation.Insum,introducingactively
managedmunicipalbondportfolioscouldaddgreater
diversifcationandmorethoroughriskmitigation,and
provideabroaderopportunitysetforincreasingvalue.
Whilethemunicipalmarkethasevolvedinrecentyears,
municipalbondsremainstrategicallyimportantinvest-
mentswithsignifcanttaxadvantagesandgenerallylow
correlationstootherassetclassesovertime.Currently,
webelievethismaybeanattractiveentrypointfor
municipalbondinvestors,andonewaytodothatisto
useactivelymanagedfundsinplaceoforasacomple-
menttoindividualbonds.Relyingonprofessional
managersanddeepresearchteamstotakeadvantage
oftimelyopportunitiesprovidesnotonlythepotential
foradditionalreturnforinvestorsbutbroaderdiversif-
cationandriskmitigationinamarketenvironmentthat
ismuchmorechallengingtonavigatetodaythanitwas
onlytenyearsago.
Figure 9. Long-dated munis are out-yielding comparable Treasuries even without the tax advantage

Muni/Treasury
ratios Averages Standard deviation
Jan. 20, 2012 Since 1990 Since 1998 Since 2000 Since 1990 Since 1998 Since 2000
5 years 92% 80% 83% 84% 12% 14% 15%
10 years 90 83 88 89 9 10 11
30 years 107 91 98 99 12 12 13
Sources:MMD,Bloomberg,PutnamInvestments,asof1/20/12.
Fundamental research, when properly implemented, can help mitigate
risk by identifying potentially deteriorating credits in the municipal bond
market, which may either be sold from the portfolio or avoided altogether.
FEBRUARY 2012|Evolving municipal bond market makes compelling case for active management
EO1442733702/12
Thalia Meehan is a Portfolio Manager within Putnams
Tax Exempt Fixed Income Group. She earned a B.A.
from Williams College, is a CFA charterholder, and has
worked in the investment industry since 1983. She is a
member of the Boston Security Analysts Society and
the Society of Municipal Analysts.
Paul Drury is a Portfolio Manager within Putnams Tax
Exempt Fixed Income Group. He earned a B.A. from
Sufolk University, is a CFA charterholder, and has
worked in the investment industry since 1989.
Susan McCormack is a Portfolio Manager within
Putnams Tax Exempt Fixed Income Group. She earned
a B.A. from Dartmouth College and an M.B.A. from
Stanford University, is a CFA charterholder, and has
worked in the investment industry since 1986.
The views and opinions expressed are those of the authors, are subject to change with market conditions, and are not
meant as investment advice. Companies and municipalities referenced may or may not be Putnam fund holdings.
Consider these risks before investing:Capitalgains,ifany,aretaxableforfederaland,inmostcases,statepurposes.
Forsomeinvestors,investmentincomemaybesubjecttothefederalalternativeminimumtax.Incomefromfederally
exemptfundsmaybesubjecttostateandlocaltaxes.Fundsthatinvestinbondsaresubjecttocertainrisksincluding
interest-raterisk,creditrisk,andinfationrisk.Asinterestratesrise,thepricesofbondsfall.Long-termbondsaremore
exposedtointerest-rateriskthanshort-termbonds.Unlikebonds,bondfundshaveongoingfeesandexpenses.
Diversifcationdoesnotassureaproftorprotectagainstloss.Itispossibletolosemoneyinadiversifedportfolio.
Dataishistorical.Pastperformanceisnotaguaranteeoffutureresults.Aswithanyinvestmentthereisapotential
forproftaswellasthepossibilityofloss.
Request a prospectus, or a summary prospectus if available, from your fnancial representative or by calling
Putnam at 1-800-225-1581. The prospectus includes investment objectives, risks, fees, expenses, and other
information that you should read and consider carefully before investing.