Market change drives new
interest in US muni bonds

  • Tweet
  • Share on LinkedIn
  • Share via email
  • Print

November 2, 2021
 

What appeal could the US municipal bonds hold for institutional investors? Here, Jefferey Burger, portfolio manager municipal bonds, at Insight Investment, makes a case for this opportunity-rich asset class.

Insight portfolio manager Jeffrey Burger is keen to raise investment awareness among overseas investors unfamiliar with US municipal bonds. He considers issuers of municipal bonds such as US states and local governments to be “perpetual ongoing concerns and natural monopolies”— which can provide both yield and a low risk profile.

Like many investors, Burger wonders what a post–Covid economy will look like. Markets are already seeing the concerns of inflation and rising interest rates take their effect on uneasy investors as they potentially shift into asset classes which historically have had no correlation to municipal bonds, such as equities.

“We believe that the municipal bond asset class is well-positioned to help reduce risks in an uncertain future,” says Burger.

But just what can municipal bonds offer investors?

Burger cites:

  • High credit quality, especially compared to corporate securities
  • Limited price volatility—particularly important given the unknowns in the fixed-income world going forward
  • A large, diverse market
  • Heterogeneous security-specific exposure—diversification across the entire US
  • Solvency scoring—municipal bonds score well
  • Income component—attractive relative to US Treasuries and corporates
  • Correlation benefits—strong diversifier to risk exposure

Further, in the US Federal Reserve (Fed) tightening cycle we’re most likely about to see, municipal bonds, as a fixed-income instrument, have historically outperformed other asset classes while under interest-rate pressures. “When interest rates rise, there’s more tax advantage to municipal bonds,” says Burger. “And as taxes may go up, there may be more demand for this asset class.”

“From a thematic perspective,” Burger adds, “municipal bonds provide investors an opportunity to invest in infrastructure with fixed-income returns and lower risks”—just at the same time there is a major government push to invest broadly in US infrastructure. In effect, this means the government will subsidize debt service for municipalities by offsetting costs.

Municipal bonds are the primary funding source for US infrastructure—as opposed to private capital or the government. The types of projects that municipal bonds finance are core infrastructure in areas such as transportation, energy, water, and social infrastructure—which centres on the construction and maintenance of facilities that support social services such as health care, education, housing.

What other attractions do municipal bonds hold? They occupy a large market, nearly US$4 trillion in size. There are more than 55,000 issuers (eight times that of the corporate bond market). “With that many issuers,” Burger says, “it can lead to inefficiency. And from an inefficient perspective, from where investors sit, that means opportunity.”

There also is a lack of institutional penetration in the market, with72% of it comprised of retail investors, who receive favorable tax treatment for owning a municipal bond.

“The yield advantage of owning a municipal bond is also still there, compared to corporates, US Treasuries, and sovereign debt across the world. In some ways, this isn’t even a fair comparison,” Burger says, “because the US double-A corporate market is extremely small at this point, with most US corporates at triple-B. So, to get a similar yield in the corporate world relative to municipals, you really have to go down the credit curve.”

A distinction among municipal bond funds (besides whether the bonds themselves are general obligation or revenue) is that some funds are tax-free (which offer a lower yield) and others are taxable (which owing to a tax-code change offers higher yield).

“What that change means the investor, is that he or she has the opportunity to enter into this high-quality market with higher yield than investors would have had prior to the tax reform,” he concludes.

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

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.

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.

This material has been provided for informational purposes only and should not be construed as tax advice, investment advice or a recommendation of any particular investment product, strategy, investment manager or account arrangement, and should not serve as a primary basis for investment decisions. Prospective investors should consult a legal, tax or financial professional in order to determine whether any investment product, strategy or service is appropriate for their particular circumstances. 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 publication and subject to change.

This information contains projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or expectations will be achieved, and actual results may be significantly different from that shown here. The information is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

BNY Mellon Investment Management is one of the world’s leading investment management organizations, encompassing BNY Mellon’s affiliated investment management firms 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.

Investment advisory services in North America are provided by Insight North America LLC, a registered investment adviser and regulated by the U.S. Securities and Exchange Commission (SEC). Insight North America LLC is associated with other global investment managers that also (individually and collectively) use the corporate brand Insight Investment and may be referred to as “Insight” or “Insight Investment.”

No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

© 2021 BNY Mellon Securities Corporation, distributor, 240 Greenwich Street, 9th Floor, New York NY, 10286

Not FDIC-Insured | No Bank Guarantee | May Lose Value

MARK-225390-2021-11-03