Still Opportunities with Munis, But Advisors Need to Know Where to Look

Real talk: Municipal bonds aren't glamorous and many clients aren't going to be excited to talk about this form of debt with advisors.

For as boring as most munis are, the asset class is still a fact of life for adviors and their older clients, including those in or nearing retirement. That despite the fact that the tax equivalent SEC-yield on the widely observed S&P National AMT-Free Municipal Bond Index is just 1.26%.

Yes, that's a low yield and it reinforces the 2021 mission of being creative, though not risky, in search of income. Even with the paltry yields, municipal bonds still offer benefits to clients.

“We don’t believe that low yields should deter investors. Combined with the tax benefits that munis can offer and the improved economic outlook, we suggest muni investors add some lower-rated (BBB/Baa2 to BBB+/Baa1) issuers to their portfolio in moderation,” says Cooper Howard of Charles Schwab. “Interest payments for municipal bonds are generally exempt from federal and potentially state income taxes (if purchased from an issuer in your home state).”

Economic Growth Supports Muni Case

Traditionally less volatile and lower yielding than corporate bonds, munis still have elements of credit considerations. Fortunately, economic growth and federal financial assistance is backstopping some of the states that were in precarious fiscal positions prior to and immediately following the onset of the coronavirus pandemic.

That is to say with the economy expanding and, hopefully, more folks returning to the labor force at some point later this year, states and municipalities are collecting more tax revenue, thereby diminishing municipal default risk.

“Credit conditions for municipal bonds have improved considerably from a year ago, which reduces the risk of downgrades and defaults,” adds Schwab's Howard. “This is due to the substantial fiscal support provided to state and local governments as well as the swift economic recovery. Moreover, economic growth is expected to be strong going forward, with consensus estimates for gross domestic product (GDP) growth currently above 6% in 2021 and above 4% in 2022 based on Bloomberg estimates.”

State tax revenue has fully recovered to pre-pandemic in 20 states, though California and Illinois – often two of the largest members of municipal bond benchmarks – aren't in that group. Fortunately, Texas, Florida and New York – the second- through fourth-largest states, respectively, are.

Jumping for Junk

Among the ways advisors can add some spice (in conservative fashion, of course) to muni conversations is by bringing up the concept of junk-rated municipal debt. It's a good time to do so because that asset class is performing quite well this year.

“Lower-rated munis have been on a tear this year relative to their higher-rated counterparts. Over the past 52 weeks, the BBB rated portion of the muni market has outperformed the AAA rated portion by roughly 7.5%, based on the Bloomberg Barclays Municipal Bond Index,” adds Howard. “Although the outperformance gap has narrowed a bit recently, this is still near a decade-long peak for BBB rated issuers.”

There are several broad-based, fee-friendly funds in this space, including the SPDR Nuveen Bloomberg Barclays High Yield Municipal Bond ETF (NYSEARCA:HYMB).

HYMB has a tax equivalent yield of 3.24%, which is borderline staggering in the muni space these days. With an option-adjusted duration of 6.30 years, HYMB is home to 1,776 bonds, providing clients with a deep bench that's not exceptionally risky at the credit level. Over 16% of the fund's holdings are rated at least “A” and about 45% carry a rating somewhere in the “B” family.

HYMB isn't perfect, but it's a solid foundation for adding some more yield to an asset class sorely lacking it.

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