Investors are snapping up muni funds. Why the good times may last
Volatility hasn’t dampened demand for municipal bonds. The assets performed dismally in March but rebounded in April. In fact, the ICE BofA US Municipals Securities Index posted its first positive April since 2021 and the strongest one since 2014. Munis are free of federal tax and, if the holder lives in the state in which the bond is issued, also exempt from state tax. Maybe as a result, investors have piled into muni bond funds at the fastest rate since 2021. Municipal mutual and exchange-traded funds saw net inflows of about $22.3 billion in the first four months of the year, according to LSEG Lipper Global Fund Flows. Investors were able to snap up some deals in April after March’s repricing, but AllianceBernstein’s Matt Norton still sees a compelling entry point right now. “The all-in yields are still over attractive from an income generation perspective,” said Norton, the firm’s chief investment officer for municipal bonds. A muni portfolio that has a 4% tax-free yield means investors in the higher tax brackets could approach a 7% tax-equivalent yield, he noted. Bond yields move inversely to prices. “Given the relative safety of the municipal bond market, and what we think are attractive valuations, that could lead to pretty strong performance over the next 12 to 18 months,” he added. VTEB YTD mountain Vanguard Tax-Exempt Bond ETF year to date performance Meanwhile, UBS recently turned positive on the asset class too, shifting its house view to “attractive.” “We believe munis are poised to deliver strong performance over the next several months,” Sudip Mukherjee, senior fixed income strategist in the UBS chief investment office, said in a note last week. “Yields are attractive, technicals are expected to improve, the curve remains steep and credit remains resilient.” Still, Barclays is reminding investors to stay on their toes in the event of any uptick in macroeconomic risk. “In our view, tax-exempts should do fine in May, but if rate volatility starts picking up again on the back of Iran-U.S. tensions, the going will get harder,” Mikhail Foux, head of Barclays’ municipal research and strategy, said in a note last week. “As a result, investors might be better off exercising caution again, and adding on weakness if opportunities present themselves.” Finding opportunities While ample supply is expected this year, Norton at AllianceBernstein believes the demand is adequate thanks to the bonds’ attractive valuations and solid income. The yield curve is also steep from a historical standpoint, he said. “There’s a lot of attractive, relative value as you go out the yield curve,” Norton said. “We think that if you’re buying 15- to 30 year bonds, those will be amongst the best performers.” He likes credits with ratings A, BBB, or even higher yielding assets, which he said have strong credit fundamentals, are still very strong and where valuations remain attractive. Looking at sectors within revenue bonds, Norton prefers affordable housing and senior housing. “Many of the affordable housing projects that are financed in the municipal bond market remain very highly occupied,” he said. “The historical default rates are quite low, and it’s a sector where we think that you can get additional yield, but also experience fairly resilient credits — even if the economy were to slow, generally, occupancy in affordable housing remains fairly high.” Senior housing is benefiting from an aging population , he noted. UBS likes the 20-year portion of the curve for absolute returns over longer investment horizons. It favors high quality bonds and recommends a 75% allocation to AAA- and AA-rated assets, and 25% in A-rated. Meanwhile, Eric Kazatsky, client portfolio manager at MacKay Shields, has moved from general obligation to revenue bonds. “We just see better relative value with essential service credits like water and sewer, public power, things like that. Even transportation,” he said. These have identifiable revenue streams and often have better covenant protection, which are binding terms of the bond, he noted. Kazatsky is also focused on curve positioning and finds the most attractive part in the 17- to 22-year area. Overall, he believes munis are quite attractive now, particularly compared to the risk you are taking in other fixed-income assets. “We are outperforming Treasurys. We are outperforming corporates,” Kazatsky said. “We’re outperforming a lot of other areas of fixed income and given the amount of risk you’re taking in munis with those very, very low historical default rates, it’s kind of impressive.”
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