Munis' time to shine
Faced with narrow credit spreads and falling interest rates, some investors searching for income have been chasing yield in risker sectors such as non-investment-grade debt and emerging-market bonds. But it might be better if they don’t catch any there. These types of investments often can have a high correlation to equities, which historically have been volatile when recession fears surface. You might get lucky for a while, but when it runs out, watch out.
This is when municipal bonds can shine. In uncertain times, munis can provide yields that add to—rather than test—an investor’s portfolio. They have the potential to provide a combination of credit quality, tax-exempt income and diversification that can serve investors of any tax bracket, risk preference or age.
The need for less-risky income-producing assets is crucial today. Coupon return has become the key driver of return and may be so for a considerable time. Munis check both boxes. On top of that, when factoring in the tax-advantages, investment-grade and high-yield munis may offer comparable yields to many taxable sectors while reducing sensitivity to equity-market volatility.
Furthermore, if the municipal yield curve continues to be steeper than the Treasury curve, investors could be rewarded for moving further out on the maturity spectrum. We feel that adding even a moderate amount of duration (interest-rate exposure) by moving to the intermediate portion of the municipal yield curve could provide significant additional income for investors willing to accept the greater volatility associated with longer-term bonds.
This approach is not only attractive in the current low-rate, low-inflation environment, but may help investors achieve retirement needs. Employees are shouldering more and more of the cost of retiring as a result of companies shifting from defined benefit pension plans to 401(k)s. Outside of retirement plans, municipal bonds are one of the only tax-advantaged investments left. Intermediate munis may be part of the answer for an investor’s portfolio mix.
Sometimes it’s better to be good than lucky.