Fixed-income investors seeking to diversify their holdings can look to municipal bonds and related exchange traded funds for their attractive yields, especially in a taxable investment portfolio.
On the recent webcast, Goundhog Day: Will the Muni Market See Its Shadow in 2016?, Ashton P. Goodfield, Co-Head of the Municipal Bond Department and Portfolio Manager for Municipal Bond Mutual Funds at Deutsche Asset Management, noted that tax changes in 2013 lifted the top tax bracket to 39.6% in federal and 3.8% on investment income.
However, municipal bonds are exempt from both of these tax impediments on returns. For instance, Goodfield calculates that a 3.00% muni yield in 2012 equated to a taxable equivalent yield of 4.62%, but with a higher tax rate now, a 3.00% yield would show a taxable equivalent 5.30% yield for those in the highest income bracket.
“Higher taxes make the municipal bond exemption more valuable,” Goodfield said.
Matthew Forester, Chief Investment Officer of NewSquare Capital, also pointed out with higher taxes, demand is increasing for these tax-exempt investments.
“Higher rates drive millions of households into a need for tax-exempt income,” Forester said.
Goodfield also argues that municipal debt can offer attractive diversification benefits as well. Investors may find that their muni positions may zig as other investments zag, which will helps diminish a portfolio’s overall volatility.
“Municipal bonds have historically offered low correlations to both equities and other areas of fixed income,” Goodfield added.
The asset has also helped buoy investor portfolios in times of distress. Over the past three decades, the Barclays Municipal Bond Index has only showed four negative calendar-year returns.
[related_stories]A Federal Reserve rate hike is one of the biggest risks that fixed-income investors face today. The Fed, though, has been pushing off on an additional rate hike and stated that there will likely only be two hikes this year. Nevertheless, Deutsche believes that munis could hold up better than other categories in a rising rate environment.
“Given the current uncertainty around interest rates, fixed-income positions are at greater risk of losing value, tax-exempt municipal bonds could potentially lessen this impact,” Lisa Poniewaz, ETF Regional Vice President at Deutsche Asset Management, said.
Investors interested in tapping into the muni bond market can look to the Deutsche X-Trackers Municipal Infrastructure Revenue Bond Fund (NYSEArca: RVNU), an efficient way to invest in lower quality investment-grade and longer maturity municipals, Goodfield said.
RVNU is the only U.S.-listed ETF that tracks long-term, investment-grade U.S. tax-exempt munis with dedicated revenue streams. The underlying index is intended to track federal tax-exempt municipal bonds that have been issued with the intention of funding, state and local infrastructure projects such as water and sewer systems, public power systems, toll roads, bridges, tunnels, and many other public use projects. The index will attempt to only hold those bonds issued by state and local municipalities where the interest and principal repayments are generated from dedicated revenue sources.
RVNU includes about a 67% tilt toward A- and BBB-rated debt, along with a 76% position in 20+ year maturities. The longer duration and slightly lower quality mix helps RVNU come with a yield-to-worst of 2.60%, compared to the 2.11% yield-to-worst for the Barclays Municipal Bond Index.
Financial advisors who are interested in learning more about the municipal bond market can listen to the webcast here on demand.