This muni fund harnesses Fidelity's research machine to generate low-risk tax-favored income. By Elizabeth Leary, Contributing Editor July 31, 2007 Municipal bond funds offer more than just tax-free income these days. For bond investors worried about the subprime loan crisis, they also provide protection against spillover problems from the riskier parts of the bond market. That's because the issuers of tax-free municipal bonds, typically local and state governments and their agencies, rarely go belly up.Our favorite muni fund is Fidelity Intermediate Municipal Income, a member of the Kiplinger 25. One of the aspects that distinguishes the fund is its ability to tap into Fidelity's deep and talented fixed-income research team: About 25 people contribute research and analysis to the fund. All of that talent is necessary, says manager Mark Sommer. He notes that if the corporate bond market is like a supermarket, then the muni bond market is like a flea market -- "disjointed and eclectic." Analyzing munis requires careful study of both a bond's terms and the health of the issuer. The bonds are issued either as general obligation bonds, proceeds of which go into an issuer's general coffers, or as revenue bonds, which finance projects that will generate income to repay the loan through, say, road tolls or utility payments. Although munis do have much lower default rates than corporate bonds, Sommer doesn't play down what credit risks there are. He employs the help of more than ten analysts to research the creditworthiness of borrowers. On the structural side, munis tend to be much more complex than corporate IOUs, coming with call provisions and refinancing options that affect the value of an issue. The Fidelity team pulls these structural and credit concerns into models to help Sommer value issues and determine how new investments would affect the fund's overall risk level. Advertisement Based on this analysis, Sommer has been sticking with top-quality bonds. At last report, he's stashed 62% of his fund's assets in the highest-quality bonds, those with AAA ratings. The fund's charter doesn't require such a heavy concentration of top-quality issues, but Sommer says he currently doesn't see enough reward in higher-yield, lower-quality bonds to stray too far from his thoroughbred holdings. Intermediate Municipal Income returned an annualized 4.9% over the past ten year years through the end of June, placing it in the top 20% of all investment-grade muni bond funds. The fund (FLTMX; 800-343-3548) currently yields 3.8%. That's equivalent to a taxable 5.3% for investors in the 28% federal tax bracket and 5.9% for investors in the 35% bracket. Helping the fund produce an above-average yield is a well-below-average expense ratio of 0.43%. While the fund is insulated from credit concerns, it is subject to interest-rate risk (prices of bonds and bond funds typically move inversely with changes in rates). Strommer doesn't make interest-rate bets. The fund recently had an average duration (a measure of interest-rate sensitivity) of five years, suggesting that it could lose about 5% if rates rose one percentage point (or gain 5% if rates fell one point). Year-to-date through July 30, 1.2%, about twice the average of its category, according to Morningstar.