On a year-to-date basis, broad measures of municipal bonds are trailing the marquee aggregate, investment-grade and junk corporate bond indexes. However, some market observers believe the tide could soon turn in favor of munis.
That would benefit an array of ETFs, including the ALPS Intermediate Municipal Bond ETF (MNBD). One of the reasons municipal bonds and ETFs such as MNBD have scuffled this year are concerns about the fate of the 2017 Tax Cuts and Jobs Act, which contains provisions making municipal debt enticing, particularly for high earners in high tax states.
There’s the potential for good news, including the possibility of lifting the highest marginal tax rate from 37% to 39.6% in an effort to augment some of the other items in what President Trump refers to as “one big, beautiful bill.” That alteration could be a plus for municipal bonds.
“A nearly 3% increase to the top tax bracket would significantly impact the relative value of municipal debt,” noted LPL Financial. “Considering a new 43.4% top marginal tax rate (which includes the 3.8% surcharge associated with the Affordable Care Act), the investment-grade Bloomberg Municipal Bond Index taxable-equivalent yield-to-worst (YTW) would improve from its current 6.99% to 7.37%, a level that well exceeds the yield of the lowest investment-grade (BBB) corporate index.”
Valid Near-Term Case for MNBD
MNBD is an actively managed ETF — a potentially pertinent trait at a time when munis are attractive on a valuation basis.
“Starting yields remain quite attractive. With tax-equivalent yields (TEY) ranging from 7–9% (the high-quality Bloomberg Municipal Bond Index has a 6.99% TEY), we believe the value proposition for municipal bonds — particularly in the intermediate maturity category — remains compelling, though near-term volatility may persist,” according to LPL.
Perhaps boosting the case for MNBD is that munis currently stack up well against corporate bonds and Treasuries of similar maturities. Then there’s the matter of seasonality. The summer months are typically slow in terms of muni issuance. That could be important, because supply has been sizable in recent months.
Beyond the seasonality factor, municipal bond fundamentals, including low default rates, support the case for ETFs such as MNBD.
“Muni bonds, in general, have better default characteristics than corporate bonds. Since 1970, the 10-year cumulative default rate for investment grade munis is barely above zero, whereas it was over 2% for similarly rated corporate bonds,” concluded LPL. “Moreover, when compared to the riskier segments within the corporate credit universe, lower-rated/high-yield munis enjoyed a default rate more than 75% less than corporate alternatives.”
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