It was only a few months ago that investors were pulling huge sums of money out of municipal bond funds, after warnings from some experts, including economist Nouriel Roubini and analyst Meredith Whitney, that a wave of defaults by hard-pressed public agencies, towns and states could end up costing investors up to $100 billion.

Well as it happens, Morningstar muni-fund analyst Miriam Sjoblom says that there may be only about $1 billion worth of defaults by public issuers in all of 2011, which would actually be an improvement over the amount of muni defaults recorded in 2010 and 2009.

Meanwhile, she said, while investors have been slowly tiptoeing back into municipal bonds, they’ve been staying in the shallow end of the pool, buying only short and intermediate-term muni-funds, but still shying away from long-term muni funds.

“Long-term bonds funds have remained unloved,” Sjoblom said.

And yet because of this, she said the yields offered by the long-term muni funds are significantly higher than the short- and medium-term fund yields – sometimes by a spread of as much as 200 basis points for the 30-year bonds. 

This is probably something that advisors should point out to clients who are looking for long-term income streams.

Traditionally, Sjoblom notes, long-term bond funds were the “flagships” at fund houses. Retirement savers especially liked them because they provided steady, tax-free income over a long period of time and they offered more income than the shorter term bond funds.

What changed this traditional attitude was the enormous volatility that hit munis after the fiscal crisis hit in late 2008.

The municipal bond market, it turns out, is remarkably sensitive to investor sentiment because individual investors play a disproportionate role in the purchase of these instruments, either as direct buyers of bonds, or as owners of municipal bond mutual funds.

With investors anxious about bond volatility, short- and especially intermediate-bond funds overtook long-term bond funds in size. As a result of this, the yields on intermediate muni bonds have plunged.

As Sjoblom notes, the usual big institutional investors -- big financial institutions and pension funds -- have little interest anyway in long-term tax-free municipal bonds. The banks don’t have many 30-year liabilities that need to be offset and pension funds, which do, aren’t concerned about taxes.

That leaves that market largely to individual investors, who for more than half a year have been “Nervous Nellies” about these products.

As a result, Sjoblom suggests now may be a good time for advisors and investors to take a closer look at long-term muni funds.