By Brian Chappatta - 2012-10-02T04:01:00Z

Municipal bonds sold by hospitals and health-care providers are rallying the most since 2009, defying a potential $11 billion drop in Medicare funding from federal budget cuts that loom in three months.

Health-care bonds have gained 9.5 percent this year and hospital debt 9.1 percent, making them the best-performing revenue securities, Standard & Poors indexes show. The segments are beating the broader $3.7 trillion muni market by the most in three years.

The rally is poised to continue as Federal Reserve efforts to hold down interest rates spur investors to add relatively risky, higher-yielding assets. Hospital and health-care debt has an average S&P rating of A-, seventh-highest. At the same time, some bondholders are betting President Barack Obamas health- care law will limit hospitals unpaid bills.

Health care still tends to have more yield than its similarly rated counterparts, said Paul Brennan, a senior portfolio manager in Chicago at Nuveen Asset Management, which oversees about $90 billion in munis. Investors may continue to look to lower-rated bonds for yield, which is what the Fed is trying to get the market to do.

Health-related bonds have benefited from the biggest rally in four years in high-yield munis. The difference in interest rates between securities with a BBB grade, two steps above junk, and AAA securities narrowed to 1.1 percentage points in August, the smallest since 2008, data compiled by Bloomberg show. Investors are adding the debt to boost returns with muni yields rates near the lowest in a generation.

The U.S. central bank said last month that it would hold its target interest rate near zero through mid-2015 as it attempts to stimulate the economy.

The Fed is a formidable opponent and its rippling through everything, said Patrick Morrissey, who helps oversee about $2.2 billion in fixed income at Great Lakes Advisors in Chicago. Were forced into what could be perceived as riskier sectors.

Even with this years gains, health and hospital yields are higher than any other type of revenue debt, except bonds sold by local agencies for corporate borrowers or industrial projects.

The 2.95 percent interest rate on 10-year health-care bonds rated AA compares with 2.22 percent on similarly rated general- obligations, data compiled by Bloomberg show.

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Health-Care Gain Defies $11 Billion Medicare Threat: Muni Credit