Bonds that offer high yield and can ward off the threat of a potential recession offer fixed income investors an attractive option. Right now, they can get that duality in municipal bonds.
That said, investors have been lapping them up as of late, which is a stark contrast from last year’s bond debacle. Rising interest rates soured the taste for bonds amid the U.S. Federal Reserve’s monetary policy tightening, but that’s all proving to be in the past given the latest bond rally.
“Investors may have bailed out of muni-bond funds in record numbers last year, but now the asset class is not only looking attractive thanks to high yields but also appears well positioned to ride out a recession,” wrote Katherine Lynch in Morningstar, also noting the attractive yields munis are offering.
“As with the rest of the bond market, yields on municipal securities are at their highest levels in many years,” Lynch wrote further. “The average intermediate muni-bond fund stands at 3%, compared with roughly 1% just a year ago. When investors factor in the tax-exempt nature of many municipal bonds, the yield advantage is even greater, in some cases topping those found on comparable taxable-bond funds.”
Additionally, the threat of a recession looms large as the Fed continues to tighten rates. However, local governments have fortified their financial positions in order to withstand a slowdown in economic growth.
“In addition, thanks to a general trend of many state and local governments strengthening their fiscal positions over the past several years, credit quality in the muni market is seen to be exceptionally strong,” Lynch added. “That should help muni-bond funds ride out the kind of recession that could hurt corporate bonds or other credit sensitive parts of the fixed-income market.”
An Active Muni Option
For dynamic exposure to the muni bond market, consider the American Century Diversified Municipal Bond ETF (TAXF). The fund offers an actively managed strategy that allows for portfolio tailoring by seasoned portfolio managers.
The fund seeks to provide consistent tax-free income by employing an active, research-driven process that draws from across the municipal bond universe and adjusts exposure depending on prevailing market conditions. As with local government bonds in the U.S., credit risk is minimized, with close to 80% of the fund ranging in debt rated at AAA to A (as of May 31).
The fund also features a low expense ratio of 29 basis points. This should appeal to cost-conscious investors who may typically view actively managed funds as too expensive to consider.
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