Municipal bonds have long been fixed income staples in retirement portfolios, and there are renewed reasons for income-seeking investors to consider exchange traded funds such as the iShares National Muni Bond ETF (NYSEArca: MUB).
MUB seeks to track the investment results of the S&P National AMT-Free Municipal Bond IndexTM. The fund generally will invest at least 90% of its assets in the component securities of the underlying index and may invest up to 10% of its assets in certain futures, options and swap contracts, cash, and cash equivalents. The index measures the performance of the investment-grade segment of the U.S. municipal bond market. Municipal bonds give debt market investors an extra layer of safety given that local government debt typically has a lower rate of default compared to corporate bonds.
“Favorable supply-and-demand dynamics drove strong municipal bond performance in January despite a material move higher in interest rates driven by vaccine optimism and expectations for additional fiscal stimulus,” according to BlackRock research. “The S&P Municipal Bond Index returned 0.56% for the month. High yield munis posted the strongest gains, led by the more liquid tobacco and Puerto Rico bonds. The outperformance of munis versus Treasury bonds further stretched their rich valuations, pushing muni-to-Treasury ratios to all-time tights in the intermediate and long end of the yield curve.”
‘MUB’ a Strong Option for Fixed Income Investors
Municipal bonds have long been considered some of the most reliable fixed income options. Enter Covid-19 and a once untouchable space could now be in jeopardy with defaults. Nevertheless, MUB and friends are proving steady amid a spate of new issuance.
Yields on munis have been steadily falling with bond prices rising, even before the coronavirus. After the 2017 tax law changes, demand for tax-exempt munis became more attractive in response to caps in the federal deduction for state and local taxes, especially among higher-tax states. The tax law also diminished supply due to new limits on when governments can issue tax-exempt debt.
“New supply underwhelmed lofty expectations in January as issuers took a wait-and-see approach on the new administration. Taxable issuance remained proportionally elevated at 29% of total supply, depressing traditional tax-exempt issuance. In the tax-exempt market, reinvestment of income from maturities, calls and coupons outstripped issuance by nearly $16 billion, creating a powerful tailwind. New issues were oversubscribed by 11 times on average,” according to BlackRock.
Good news: February is usually a good time to embrace munis, indicating MUB could be a near-term winner.
“The month of February has produced positive total returns in 8 of the past 10 years. While rich valuations will cause a drag, we expect strong demand to continue outpacing an elevated but manageable level of issuance,” adds BlackRock. “We believe fundamentals will likely benefit from additional fiscal aid, and vaccine distribution should support longer-term revenue normalization. As the new administration lays out its agenda and tax policy comes into focus, we anticipate heightened demand for tax-advantaged assets such as muni bonds.”
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