Market rout has muni bonds looking good. How to add them to your portfolio
With the recent market turmoil, investors are looking for income. For some, municipal bonds may be the answer. The muni market has taken a hit this year, with weekly net flows into muni mutual funds and exchange-traded funds being negative for most of 2022, according to data from Refinitiv Lipper. However, their returns and tax advantages can make them an attractive investment. The debt is issued by a government entity, such as a city or state, and raises money for public projects, such as building roads or schools. You’re generally free of federal taxes on interest and can avoid state and local taxes, depending on where you live. “States are in really good shape to pay off their bonds, which makes community security even better than ever,” said certified financial planner David Sheaff Gilreath, partner and chief investment officer at Indianapolis-based investment advisor Sheaff Brock. Jason Ware, head of municipal bond trading at InspereX, has noted a “huge uptick” in buying and selling of the fixed income asset over the past two to three weeks. “Uncertainty about how high interest rates will rise has led to redemptions from municipal bond funds,” he said. “This was coupled with a heavier new issuance calendar ahead of the forthcoming Fed decision, creating supply pressure [and] drive up nominal yields and credit spreads and make them much more attractive.” The tax benefits make Munis particularly attractive to high earners in high income tax states. Those tax cuts are even more important at a time when stock returns are scarce. The market took a nosedive on Friday as the Dow hit a new yearly low.” “We always like to buy municipal bonds,” said CFP Ian Weinberg, CEO of Family Wealth and Pension Management in Woodbury, New York. “When interest rates were very low, it wasn’t that exciting, but today it’s a pretty good deal. Now, whenever we have an opportunity to add to municipal bonds, we do so.” A good buy signal is when municipal yields are at least 85% of equivalent Treasury yields over a given duration, he said. That’s because with a treasury, you pay taxes on your interest income. Therefore, even if a highly rated municipal bond with the same maturity has a lower yield, you can still earn more since they are generally not taxed. For example, a 12-year bond A tax-exempt California bond that pays a 4% semi-annual coupon, with essential service or general obligation coverage, can earn you a 3.7% yield, said InspereX’s Ware — that is, for one wealthy private individual in the top tax bracket This corresponds to a taxable return of 6.25% Meanwhile, the 10-year government bond is currently yielding just under 3.7% How do you buy Munis? , You can use a broker-dealer, engage an investment manager, or trade. d directly through a self-managed online account. For example, you can go to the Fidelity Investments website and access more than 50,000 municipal bonds from new issues or through dealers in the secondary market. However, if you decide to do your own direct buying, you should do your homework, said Richard Carter, Fidelity’s vice president of fixed income. “Investors considering a strategy involving municipal bonds should first ensure they understand these offerings and how they fit into their overall financial plan,” Carter said. Fidelity also offers municipal pension funds and exchange traded funds, as well as separately managed municipal accounts. Both Ware and Weinberg advise against going it alone when buying individual municipal bonds. There are so many different issuers and choices in bonds, and there are credit ratings to consider. There are also price differences, with smaller investors usually being disadvantaged. “You don’t want to be the bondholder who got greedy for additional yield and bought the wrong bond,” Weinberg said. They suggest working with a professional who can manage the account. You can also get muni bond exposure through a mutual fund or ETF. Those who want a wide range of bond exposures, such as maturities, sectors and credits, and have limited funds might consider investing in a mutual fund or ETF, according to the Municipal Securities Rulemaking Board. Individual Bonds vs. Funds When buying individual municipal bonds, work with a financial advisor or bond manager and focus on securities with good credit ratings, such as general notes, voter-approved and essential services, suggests Ware, who is based in San Francisco is. Fees vary, with managers typically charging a percentage of assets under management. The advantage of owning bonds over investing in a fund is that if you hold the bond to maturity, you get your principal back, he explained. You can also control your credit risk and build your own portfolio. A separately managed account instead of a fund also allows you to rank munis by investing in multiple bonds with different maturities. That’s a good strategy, especially when interest rates are rising, Ware said. When interest rates rise, you have capital due that you can reinvest at higher interest rates. There’s also good tax management in the separately managed accounts, said Weinberg of Family Wealth and Pension Management. “If some bonds are in loss positions, the manager can use those losses to recover losses for tax purposes against future gains on other investments,” he said. Weinberg uses an institutional municipal bond manager to manage its clients’ tax-exempt bond portfolios. However, he believes this route is best for those investing at least a quarter of a million dollars so they can get the right diversification. For those who may have less money to invest, a mutual fund or ETF might be a better option, he said. “There is nothing wrong with that. It just doesn’t give you as much security as your investment in municipal bonds,” Weinberg said. Here are five Morningstar five-star rated municipal pension funds. For Sheaff Gilreath, funds are exactly where he wants to be. Specifically, he said he invests in closed bond funds because that’s where you can buy the cheapest bonds. “Many closed-end bond funds trade at prices below their net asset value,” he said. He likes Putnam Managed Muni Income and Rivernorth Flexible Muni Income funds. Putnam has a distribution yield of 6.37% and currently trades at a discount of 4.44% to its net asset value. Rivernorth trades at a discount of 11.43% and has an 8.26% payout yield. Whether you’re self-employed or using a fund, financial advisor, or separately managed account, make sure you do your research and understand any fees that will apply.