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Municipal Bonds
5 charts on the relative opportunity in muni bonds
Neil Amirtha
Fixed Income Product Manager
Greg Ortman
Fixed Income Investment Director

Prospects for a rise in the corporate tax rate are bringing municipal bonds back into focus for institutional investors. Although widely viewed as an asset class for retail and high-net-worth investors, the reality is that the institutional investor base has grown and now makes up nearly a quarter of the $4 trillion muni bond market. Banks and insurers represent the largest institutional segments.


Instititional investors represent nearly a quarter of the market

Pie chart shows that institutional investors now make up nearly one quarter of the muni bond market. These include banks, which hold 12% of the outstanding bonds, as well as property and casuality insurers (7%) and life insurers (5%). The remaining sectors are households (44%), mutual funds (21%) and all other (11%). Sources: Bloomberg, Federal Reserve. Data as of December 31, 2020.

Sources: Bloomberg, Federal Reserve. Data as of December 31, 2020.

1. Muni bonds could look increasingly attractive relative to corporate bonds


As widely expected, President Biden’s proposed American Jobs Plan would raise the corporate tax rate to 28% from 21% to help pay for some $2.25 trillion of new infrastructure development. At a 28% tax rate, tax-exempt muni bond yields would look increasingly attractive relative to corporate bonds, especially in the AA- and A-rated segments, where corporate bond yields are relatively low. Investors seeking higher yields in the corporate market must move down the credit rating scale, increasing the credit risk they must assume to achieve taxable yields that are commensurate with the tax-adjusted yields of munis. Moreover, in the higher rated segments of the market, the opportunity set is much larger in the muni bond market.


Municipals have more weighting than corporates at the highest rated tiers

Bar chart shows the percentage of the investment-grade muni bond and corporate bond markets represented by each rating category. Investment-grade refers to bonds rated BBB/Baa and above. AAA-rated bonds represent 15% of the muni market and 2% of the corporate market. AA-rated bonds represent 51% of the muni market and 7% of the corporate market. A-rated bonds represent 26% of the muni market and 40% of the corporate market. BBB-rated bonds represent 8% of the muni market and 50% of the corporate market. Source: Bloomberg. Data as of March 31, 2021. Based on the Bloomberg Barclays Municipal Bond Index and Bloomberg Barclays U.S. Corporate Bond Index.

Source: Bloomberg. Data as of March 31, 2021. Based on the Bloomberg Barclays Municipal Bond Index and Bloomberg Barclays U.S. Corporate Bond Index. Chart shows the percentage of the investment-grade (BBB/Baa and above) municipal bond and corporate bond markets represented by each rating category.

2. Muni bonds have modestly lower default rates


Relative credit risks are also apparent in comparative default rates. Tax-exempt muni bonds have a lower cumulative default rate across every investment-grade (BBB/Baa and above) rating segment compared to similarly rated corporate bonds.


Municipal bond default rates have remained low

Bar chart compares default rates across investment-grade (BBB/Baa and above) rating categories for municipal and corporate bonds. Muni bonds have a lower default rate than corporate bonds across every rating category, with the biggest differences in the AA/Aa and A rating categories. At the Aa rating level, muni bonds have a 0.0% default rate, compared with 0.6% for corporate bonds. At the A rating level, the muni bond default rate is 0.3%, compared with 1.0% for corporate bonds. At Baa, the default rate is 1.6% for muni bonds, compared with 1.7% for corporate bonds. Source: Moody’s Investors Service. Data as of December 31, 2019.

Source: Moody’s Investors Service. Data as of December 31, 2019. Investment-grade bonds are those rated BBB/Baa and above.

3. Realized volatility of muni bonds has been lower than Treasuries and corporates


As a portfolio diversifier, tax-exempt muni bonds can help reduce volatility in a fixed income portfolio. Realized volatility over the past five years has been less than that of Treasuries and investment-grade corporate bonds. Much of that mitigation of volatility is due to embedded call options in most muni bonds, whereby duration declines as yields decline (negative convexity). Note this in the below chart that reflects the annualized five-year standard deviation of daily returns.


Historical volatility is relatively lower for municipal bonds

Bar chart shows the volatility, as measured by the annualized 5-year standard deviation of daily returns, across investment-grade (BBB/Baa and above) muni and corporate bonds and U.S. treasuries. The chart shows corporate bonds have the highest volatility at 5.9%, while muni bonds have the lowest volatility at 3.9% and Treasury securities fall in the middle at 4.1%. Source: Bloomberg. Data as of April 30, 2021. Investment-grade muni bonds are represented by the Bloomberg Barclays Municipal Bond Index, investment-grade corporates by the Bloomberg Barclays U.S. Corporate Bond Index and U.S. Treasuries by the Bloomberg Barclays U.S. Treasury Index.

Source: Bloomberg. Standard deviation of annualized daily returns. Data as of April 30, 2021. Investment-grade (BBB/Baa and above) municipal bonds are represented by the Bloomberg Barclays Municipal Bond Index, investment-grade corporates by the Bloomberg Barclays U.S. Corporate Bond Index and U.S. Treasuries by the Bloomberg Barclays U.S. Treasury Index.

The lower volatility of tax-exempt muni bonds combined with the tax-exempt yield has resulted in strong risk-adjusted results. For institutional investors that focus on steady and strong risk-adjusted returns, muni bonds can make a suitable complement to a broader portfolio. Combined with a higher proportion of higher quality bonds to other high-grade segments of the fixed income market and a tax-exempt income stream, tax-exempt muni bonds are also an attractive opportunity for institutional investors facing potentially higher tax rates.


4. Risk-adjusted returns are similar to investment-grade corporates and higher than Treasuries


Muni bonds have shown better risk-adjusted returns, as measured by dividing the return by standard deviation, that are similar to investment-grade (BBB/Baa and above) corporates but higher than Treasuries. Given the different credit profile of muni bonds – representing the credit risk of municipalities vs. corporations – muni bonds can provide diversification and stronger returns in a portfolio.


Stronger results on a risk-adjusted basis for municipals

Bar chart shows annualized 5-year risk-adjusted results, as measured by the return divided by the standard deviation of each respective index, across investment-grade (BBB/Baa and above) munis, up 0.96%; investment-grade corporates, higher by 0.95%; and Treasuries, up just 0.52%. Source: Bloomberg. Data as of March 31, 2021. Investment-grade muni bonds are represented by the Bloomberg Barclays Municipal Bond Index, investment-grade corporates by the Bloomberg Barclays U.S. Corporate Bond Index and U.S. Treasuries by the Bloomberg Barclays U.S. Treasury Index

Source: Bloomberg. Data as of March 31, 2021. Based on the Bloomberg Barclays Municipal Bond Index, Bloomberg Barclays U.S. Corporate Bond Index and Bloomberg Barclays U.S. Treasury Index. Chart shows annualized 5-year risk-adjusted results, as measured by the return divided by the standard deviation of each respective index.

The bottom line: Formerly an asset class utilized primarily by retail and high-net worth investors, munis are gaining traction from institutional investors. Taking into consideration the competitive returns, relatively low volatility and default track record of muni bonds, historical risk-adjusted returns have been attractive relative to Treasuries and investment-grade corporate bonds. It’s reasonable to expect the share of institutional investors that make up the muni bond market to grow when taking into consideration potentially higher taxes going forward.



Neil Amirtha is a fixed income product manager with 16 years of industry experience (as of 12/31/20). He holds a bachelor’s degree in economics from the University of Illinois at Chicago.

Greg Ortman is a fixed income investment director with 26 years of industry experience (as of 12/31/20). He holds a master’s degree in economics from Claremont Graduate University and a bachelor’s degree in economics from St. Edwards University in Austin, Texas, graduating cum laude.


Bloomberg® is a trademark of Bloomberg Finance L.P. (collectively with its affiliates, “Bloomberg”). Barclays® is a trademark of BarclaysBank Plc (collectively with its affiliates, “Barclays”), used under license. Neither Bloomberg nor Barclays approves or endorses this material, guarantees the accuracy or completeness of any information herein and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Bond ratings, which typically range from AAA/Aaa (highest) to D (lowest), are assigned by credit rating agencies such as Standard & Poor's, Moody's and/or Fitch, as an indication of an issuer's creditworthiness.
 

Bloomberg Barclays Municipal Bond Index is a market-value-weighted index designed to represent the long-term investment-grade tax-exempt bond market. This index is unmanaged, and its results include reinvested distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or U.S. federal income taxes.
 

The Bloomberg Barclays U.S. Corporate Bond Index measures the investment-grade fixed-rate taxable corporate bond market. It includes U.S. dollar-denominated securities publicly issued by U.S. and non-U.S. industrial, utility and financial issuers.
 

Bloomberg Barclays U.S. Treasury Index measures U.S. dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury.

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