Capital Group portfolio manager Karl Zeile discusses the possible impact of post-election tax reform on municipal bonds and highlights the potential benefits of munis beyond the tax advantage.
Karl Zeile: We are in the midst of an election year, and we will see a change in administration this time around, regardless. And whenever that happens, the question of tax treatment on municipal bonds comes up. Most of the time, there’s very little change. But I think it’s reasonable to think that, regardless of who is our next president, tax reform will be on the table.
The Obama administration, historically, has spoken in favor of a cap on the tax exemption at 28%. That very well [could] resurface. At current valuations, that will have an impact on the municipal bond market, but I don’t think a significant one.
If you pay taxes in the United States — and especially if you’re in one of the highest tax brackets here in the U.S. — and you want to own fixed income, you absolutely need to look at owning municipal bond funds as part of your fixed income allocation, if not your entire allocation. Based on current valuations, municipals look attractive. I think munis have lended themselves to provide the type of stability in a diversified portfolio [and] the lower correlations with the equity markets that investors should desire.
All of those things provide value to owning municipal bonds even over and above the relative tax advantages. For years, there has been plenty of talk about thinking about muni bonds relative to taxable bonds. And while I think that is worthwhile to think about and, obviously, understand, I think also an investor needs to look at the characteristics of the municipal bond market: the fact that it’s U.S.-dollar based, the fact that it does not have exposure to things like emerging markets, Europe, non-dollar securities. None of those things are a part of the municipal bond market.
We’re constructing portfolios that have had a tendency to have relatively low correlations with equities and, more recently, relatively low correlations with other risk assets in the credit markets, which have made them a very, very viable alternative to Treasuries in a broadly diversified portfolio.
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