Rising interest rates are punishing Treasuries, and other forms of high-quality debt are going along for the ride, including municipal bonds.
That creates a quandary for investors because municipal bonds have long been staples of fixed income portfolios, particularly for investors who need dependable, low-risk income, including retirees and those nearing retirement.
Fortunately, some positive signs are materializing for muni exchange traded funds, including the American Century Diversified Municipal Bond ETF (NYSEArca: TAXF).
“Hard-hit municipal bonds now yield 2% or more, and top-grade munis carry about the same yields as Treasuries for 10-year and 30-year maturities, making them and their tax advantages attractive alternatives to U.S. government bonds,” reports Andrew Bary for Barron’s.
TAXF has another feather in its cap that’s highly relevant in today’s environment: It’s actively managed. That’s a potential benefit for investors because TAXF’s managers can better address interest rate risk — a primary headwind for municipal bonds — than rival index-based strategies.
Broadly speaking, investors are pulling cash from municipal bond funds this year — an obvious result of rising interest rates. However, some market observers recommend a contrarian approach to the asset class over the near-term.
According to Barron’s: “This is a good time to take a look,” says Peter Hayes, head of the municipals group at BlackRock. “You’re getting the benefit of tax-free income for free.”
The $217.66 million TAXF attempts to top the S&P National AMT-Free Municipal Bond Index, and by way of being actively managed, it can capitalize on credit opportunities by allocating up to 35% of its line-up to high-yield munis. While junk-rated municipal bonds reward investors with higher yields due to elevated credit risk, these bonds are usually less volatile than high-yield corporates.
With a duration of five years, TAXF is in intermediate-term territory, and its credit profile isn’t risky. The fund devotes about 12% of its weight to bonds rated BBB, BB, and B, while another 9.44% aren’t rated, according to issuer data. The rest of the portfolio is rated AAA, AA, or A.
Nearly a quarter of TAXF’s state exposure is directed to bonds issued by California and New York. Those are high tax states with economies that are rebounding from the coronavirus pandemic, indicating that there’s more than adequate revenue to service municipal bond obligations.
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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.