Why an Actively Managed Municipal
Bond Fund Makes Sense

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High-net-worth investors have long looked to municipal bonds to shelter income from taxes and to preserve capital. But a more complete range of benefits may be available when they are part of an actively managed, diversified portfolio.

The traditional appeal of municipal bonds

Tax exemption — Municipal bonds have always offered protection from federal taxes. With the deductibility of state and local taxes capped at $10,000, this feature is more attractive than ever.1

Income — In a world of record-low interest rates, municipal bonds still offer attractive taxable-equivalent yields for those in the highest tax brackets.

 

Seeking stability – Much of the municipal market consists of securities backed by services that are less affected by economic downturns — schools, hospitals, water & sewer systems, and public transit, among others.

Generally lower rates of default to corporate issuers — Municipal bonds experience low default rates, even when compared to corporate issuers with comparable credit ratings. Muni issuers can manage their revenue streams to keep making bond payments – raising taxes and fees, and if necessary, cutting services.2

Federal support — In our view, the municipal market enjoys support from Congress, as indicated by the longstanding exemption of municipal bond income from federal taxes. In addition, the Federal Reserve’s $500 billion Municipal Liquidity Facility, established in March 2020 as a financial backstop during the COVID-19 pandemic, affirms the importance of the muni market.

How Munis May Benefit Your Portfolio

Investment opportunities — The number of securities and issuers in the municipal bond market means that opportunities may be abundant. Though smaller than the corporate market, the muni market’s range of securities and issuers to consider is much greater.

In addition to general obligation bonds issued by cities, states, counties and school districts, the municipal market includes revenue bonds. These are backed by the cash flows of:

  • Transportation systems
  • Healthcare facilities
  • Power utilities
  • Water & sewer systems
  • Tobacco settlement securitizations
  • Other local services

Some revenue bonds are backed by low-risk, essential services. Others offer higher yields, including those backed by toll roads, industrial development, and tobacco securitizations.  

Diversification — Spreading investments across a variety of asset classes may not only reduce portfolio volatility, it may also improve returns over the long run. Municipal bonds may add ballast to your portfolio, offsetting any volatility in stocks and other asset classes.

The table below shows that although the performance of municipal bonds is highly correlated with the performance of Treasuries and corporate bonds, it does not correspond closely with high yield bonds or stocks. (A correlation of 1.00 indicates a one-to-one correspondence.) This means municipal bonds may provide stability to a portfolio with exposure to stocks and high yield bonds.

Charts are provided for illustrative purposes and are not indicative of the past or future performance of any BNY Mellon product.  Please see important definitions at disclosures.  Investors cannot invest directly in an index.

No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Asset allocation and diversification cannot assure a profit or protect against loss.

Total return – Municipal bonds have offered competitive total returns. The Bloomberg Barclays Municipal Bond Index has outperformed Bloomberg Barclays Aggregate Index—a measure of U.S. investment-grade bond market performance— the broader bond market, in 13 of the past 20 years

 

Source: thebalance.com: Municipal Bonds Historical Calendar Year Returns October 29, 2019 *This study ended 2019.Charts are provided for illustrative purposes and are not indicative of the past or future performance of any BNY Mellon product.  Please see important definitions at disclosures.  Investors cannot invest directly in an index.

Advantages an Actively Managed Fund May Offer

Changes in the municipal bond market since the global financial crisis may make an actively managed bond fund a good option for high-net-worth investors. Actively managed funds may offer several advantages:

Credit research — An actively managed fund is backed by a sophisticated credit research team that may uncover bargains in overlooked niches of the market.

Diversification — Unlike most individual investors, an actively managed fund can hold a wide range of securities across multiple segments, issuers, and geographies.

Multiple sources of return — Active managers can often anticipate how different aspects of the market are likely to perform. Appropriately weighing different maturities, segments, and credit quality can provide various ways of earning returns.

Bigger generally allows for lower trading costs — While individual investors tend to buy and sell municipal bonds in small amounts, institutional investors make trades that are much larger, often in the millions of dollars. Data from the Municipal Securities Rulemaking Board indicates that smaller trades have higher trading costs. So, on average, individual investors have higher trading costs.3

Risk management — Actively managed municipal bond funds may employ techniques to mitigate a wide range of risks, a practice that is critical in today’s more volatile markets.

The Mellon approach

Drawing on more than 80 years of fixed-income experience, Mellon believes that municipal bond investors may be best-served by an active approach. As the world’s third-largest fixed-income manager, we offer a full lineup of actively managed municipal bond mutual funds and separately managed funds.

Not all classes of shares may be available to all investors or through all broker-dealer platforms.  Class Z shares generally are not available for new accounts.  Please see the funds’ prospectus for details. 

To learn more, click here.

 

1 The Tax Cuts and Jobs Act was passed in 2017. It placed a cap of $10,000 on deductions of state and local taxes.

2 “History of Municipal Bond Defaults,” Advisor Perspectives, citing Moody’s, June 17, 2020.

3  Municipal Securities Rulemaking Board, 2019 Factbook.

 

Investors should consider the investment objectives, risks, charges, and expenses of a mutual fund carefully before investing. Contact a financial professional or visit im.bnymellon.com to obtain a prospectus, or summary prospectus, if available, that contains this and other information about the fund, and read it carefully before investing.

All investments involve some level of risk, including loss of principal. Certain investments have specific or unique risks.

No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Asset allocation and diversification cannot assure a profit or protect against loss.

Bonds are subject to interest-rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. High yield bonds involve increased credit and liquidity risk than higher-rated bonds and are considered speculative in terms of the issuer’s ability to pay interest and repay principal on a timely basis.

The amount of public information available about municipal securities is generally less than that for corporate equities or bonds. Legislative changes, state and local economic and business developments, may adversely affect the yield and/or value of municipal securities. Other factors include the general conditions of the municipal securities market, the size of the particular offering, maturity of the obligation, and the rating of the issue. Income for national municipal funds may be subject to state and local taxes. Income may be subject to state and local taxes for out-of-state residents. Some income may be subject to the federal alternative minimum tax for certain investors. Capital gains, if any, are taxable.

Recent market risks include pandemic risks related to COVID-19. The effects of COVID-19 have contributed to increased volatility in global markets and will likely affect certain countries, companies, industries and market sectors more dramatically than others. To the extent the fund may overweight its investments in certain countries, companies, industries or market sectors, such positions will increase the fund's exposure to risk of loss from adverse developments affecting those countries, companies, industries or sectors.

This material has been distributed for informational purposes only. It is educational in nature and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Views expressed are those of the author stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this communication and subject to change. Forecasts, estimates and certain information contained herein are based upon proprietary research and are subject to change without notice. Certain information has been obtained from sources believed to be reliable, but not guaranteed. Please consult a legal, tax or investment professional in order to determine whether an investment product or service is appropriate for a particular situation.

BNY Mellon Investment Management is one of the world’s leading investment management organizations and one of the top U.S. wealth managers, encompassing BNY Mellon’s affiliated investment management firms, wealth management organization and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally.

Mellon is a global multi-specialist investment manager dedicated to serving our clients with a full spectrum of research-driven solutions. Mellon Investments Corporation (Mellon) is a registered investment adviser and an indirect subsidiary of The Bank of New York Mellon Corporation.

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. BNY Mellon Investment Adviser, Inc., Mellon (the fund’s sub-advisor) and BNY Mellon Securities Corporation are companies of BNY Mellon.

©2020 BNY Mellon Securities Corporation, distributor, 240 Greenwich St., New York, NY 10286.

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