Volatility hasn’t dampened demand for municipal bonds. Assets performed dismally in March but recovered in April. In fact, the ICE BofA US Municipals Securities Index posted its first positive April since 2021 and the strongest since 2014. Munis are exempt from federal taxes and, if the holder lives in the state where the bond is issued, are also exempt from state taxes. Perhaps this is a result of investors investing in municipal bond funds at the fastest rate since 2021. Municipal mutual funds and exchange-traded funds saw net inflows of about $22.3 billion in the first four months of the year, according to LSEG Lipper Global Fund Flows. After the March repricing, investors were able to close some deals in April, but AllianceBernstein’s Matt Norton still sees a compelling entry point at this point. “The total returns are still too attractive from an income generation perspective,” said Norton, the municipal bond firm’s chief investment officer. A muni portfolio with a tax-free return of 4% means investors in the higher tax brackets could achieve a tax-equivalent return of 7%, he noted. Bond yields move in the opposite direction to prices. “Given the relative safety of the municipal bond market and what we believe are attractive valuations, this could lead to fairly strong performance over the next 12 to 18 months,” he added. VTEB YTD Mountain Vanguard Tax-Exempt Bond ETF performance since the beginning of the year Meanwhile, UBS also recently gave this asset class a positive rating and changed its rating to “attractive”. “We believe munis will deliver strong performance over the next few months,” Sudip Mukherjee, senior fixed income strategist at UBS’ chief investment office, said in a note last week. “Yields are attractive, technicals should improve, the curve remains steep and credit remains resilient.” Still, Barclays reminds investors to remain alert in the event of an increase in macroeconomic risk. “In our view, tax holidays are likely to perform well in May, but if interest rate volatility increases again due to Iran-US tensions, things will become more difficult,” Mikhail Foux, head of municipal research and strategy at Barclays, said in a note last week. “Therefore, investors may be better off again exercising caution and exploiting weaknesses when opportunities arise.” Finding Opportunities While supply is expected to be plentiful this year, AllianceBernstein’s Norton expects demand to be sufficient given the bonds’ attractive valuations and solid yields. From a historical perspective, the yield curve is also steep, he said. “There are a lot of attractive relative values as you get off the yield curve,” Norton said. “We believe that if you buy 15- to 30-year bonds, they will be among the best performers.” He likes loans rated A, BBB, or even higher yielding assets that he believes have strong credit fundamentals, are still very strong, and whose valuations remain attractive. Looking at the sectors within the revenue bonds, Norton favors affordable housing and senior housing. “Many of the affordable housing projects being financed in the municipal bond market remain very well documented,” he said. “Historical default rates are quite low and we believe you can get additional returns in this sector but also get fairly resilient credit – even if the economy were to slow, affordable housing occupancy generally remains quite high.” Senior housing benefits from an aging population, he noted. UBS favors the 20-year portion of the curve for absolute returns over longer investment horizons. It favors high quality bonds and recommends an allocation of 75% to AAA and AA rated assets and 25% to A rated assets. Meanwhile, Eric Kazatsky, client portfolio manager at MacKay Shields, has moved from general debt to income bonds. “We are simply seeing better relative value in loans for vital services such as water and wastewater, public energy, etc., even transportation,” he said. These have identifiable revenue streams and often have better covenant protections, which are binding terms of the bond, he noted. Kazatsky also focuses on corner positioning and finds the most attractive part in the 17- to 22-year-old range. Overall, he believes munis are quite attractive right now, especially compared to the risk involved with other fixed-income assets. “We outperform treasuries. We outperform corporate bonds,” Kazatsky said. “We’re outperforming a lot of other areas of fixed income, and when you consider the amount of risk you’re taking on munis with these very, very low historical default rates, that’s pretty impressive.”
