After yields dipped lower this year, fixed-income investors may find better yield opportunities in municipal bonds and related exchange traded funds.
The benchmark 10-year Treasury yield is hovering around 1.8% after touching its lowest since May 2013 in January. Meanwhile, investment-grade 10-year municipal bond yields an equivalent 3.5% for investors in the 28% federal tax bracket, and those in higher income brackets are looking at taxable equivalent yields of 3.7% to 4.7%, Bloomberg reports.
To put this in perspective for ETF investors, the iShares 7-10 Year Treasury Bond ETF (NYSEArca: IEF), which has a 7.71 year duration, shows a 1.6% 30-day SEC yield.
In contrast, the iShares National AMT-Free Muni Bond ETF (NYSEArca: MUB) has 6.37 year duration and a 1.4% 30-day SEC yield, or 2.47% taxable equivalent yield for those in the highest income bracket. The SPDR Nuveen Barclays Municipal Bond ETF (NYSEArca: TFI) has a 7.07 year duration and a 1.83% 30-day SEC yield, or 3.04% for those in the highest income bracket. Additionally, the Market Vectors Intermediate Municipal Index ETF (NYSEArca: ITM) has 7.4 year duration and a 1.71% 30-day SEC yield, or a 3.02% taxable equivalent yield. [Muni ETFs May Be More Attractive Than Treasuries]
Marilyn Cohen, chief executive officer of Envision Capital Management, also argues that muni investors should target the intermediate duration. The 7- to 12-year range provides solid yields without the price volatility associated with long-term issues if rates begin to rise. [Diversify with a Cheap, Broad Munis Bond ETF]
Municipal bonds generate relatively higher yields than Treasuries due to their tax benefits. Specifically, municipal bonds enjoy federal tax breaks. Munis issued from the state an investor is living in are also shielded from local income tax. Additionally, for those who pay the 3.8% federal net investment income tax that’s part of the Affordable Care Act, munis are exempt from the health-care surtax.
“I tell all my high-net-worth clients they should only consider municipal bonds,” Cohen said in the article.
Moreover, a strengthening economy could also support the munis market, or at least diminish perceived credit risk.
“Growth and falling unemployment brings in more revenue for states, and rising home prices is good news for local issuers who are more dependent on property tax revenue,” J.R. Rieger, global head of fixed income at S&P Dow Jones Indices, said in the article.
Demand is also supporting the munis market. According to Morningstar data, retail investors funneled $32 billion into municipal bond funds and ETFs in 2014, with almost $11 billion coming in during the fourth quarter.
For more information on the munis market, visit our municipal bonds category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.