Fixed-income investors should consider how adding a municipal bonds ETF to the equation could be their income solution.
In the recent webcast, Not All Vanilla: Why Active Management Makes Sense in Municipal Bonds, Joseph Gotelli, VP, Portfolio Manager, American Century Investments, pointed to the value attractiveness of municipal bonds relative to Treasuries. Looking ahead, given the low interest-rate environment and the Federal Reserve expected to hold pat, investors have an incentive to move out of the curve. Consequently, American Century Investments has favored the longer intermediate-to-long end of the curve and have positioned funds for a curve flattening, overweight to the long end and underweight to the short end.
Beyond the rate-risk outlook, Gotelli argued that municipal bond exposure can help further diversify an investor’s fixed-income portfolio. For example, the low correlation to other asset classes makes the muni bond category important in a well-diversified portfolio. Investment-grade municipal bonds exhibit a trailing 10-year correlation of 0.74 to U.S. core bonds, 0.25 to U.S. high-yields, and -0.04 to U.S. equities.
The higher future tax rates outlook also makes municipals more attractive, especially with President-elect Joe Biden voicing support for tax hikes. The American Century Diversified Municipal Bond ETF (NYSEArca: TAXF) currently comes with a 1.66% 30-day SEC yield, but that means the ETF shows a 2.80% taxable equivalent 30-day SEC yield for those in the highest income bracket. In comparison, the Morningstar Intermediate Core-Plus Bond Category Average Yield was at 1.70%.
In addition, the increased demand could outstrip supply, and this trend is expected to continue. Gotelli pointed out that total Issuance is expected to be in line with 2008, but the composure of that issuance has changed dramatically. He anticipates the possibility of lower overall supply and certainly lower tax-exempt supply.
The American Century Diversified Municipal Bond ETF incorporates a top-down and bottom-up selection process to improve risk management and create a well-diversified muni bond portfolio. For example, the ETF’s management team takes a macroeconomic outlook that incorporates an economic outlook, duration, rates, and yield curve. The municipal market outlook incorporates sectors, yield curve and municipal relative value vs. taxable fixed income. The fundamental credit analysis incorporates internal credit review, economic financial strength, debt analysis, assigned internal ratings, and credit committee reviews. The relative value discussion incorporate bond pricing review, portfolio fit, and structure security analysis. The risk budgeting process incorporates position sizing, risk model review, and expected return/tracking error projections. Lastly, the buy/sell order incorporates pre-trade compliance, portfolio managers transact, and best execution prices.
TAXF’s management team also follow a fundamental credit analysis process that includes internal credit review; economic, financial strength, debt, and political risk analysis; assigned internal rating; and surveillance of ongoing issuer exposures.
“Being a diverse investment management firm means we serve a broad client base with unique financial goals,” Matt Lewis, VP, Head of ETF Implementation and Capital Markets, American Century Investments, said. “Our solutions cover a vast array of investment capabilities, as you can see here. These capabilities allow us to respond to specific client needs and also provides flexibility to offer unique investment solutions. Our ability to deliver a variety of investment solutions has become increasingly important to the various types of clients we serve.”
Financial advisors who are interested in learning more about an active muni strategy can register for the Tuesday, December 8 webcast here.