Municipal bonds are issued by state and native governments for various purposes, making the sector quite diverse. Consequently, many investors are inclined to group all municipal bonds together. Whether through energetic or passive investment strategies, munis are munis.
Nonetheless, for investors willing to dig a bit deeper, opportunities can emerge.
One in all them is municipal bonds earmarked for infrastructure opportunities. Infrastructure bonds are an exquisite way for investors to fund public assets and profit from their money flows. Offering inflation protection, stability, and potential tax savings, these infrastructure bonds could possibly be an incredible holding in your portfolio.
A Great Need
Infrastructure will be defined because the physical structures or essential services that facilitate modern society’s orderly operation. Typically, we expect of infrastructure assets as transportation-based, reminiscent of airports, toll roads, ports, and bridges; energy-focused, reminiscent of powerlines, pipelines, and solar farms; or communication-centered facilities, reminiscent of cellphone towers, server farms, and satellite dishes. Other areas reminiscent of wastewater treatment, warehouses, and even healthcare facilities often fall under the infrastructure umbrella term.
And without delay, there may be an urgent need to enhance access and increase infrastructure within the U.S.
Much of the trendy world’s infrastructure is falling apart. Following the post-World War II boom, America and far of the developed world have allowed their bridges, roads, and pipeline capability to fall into disrepair. The American Society of Civil Engineers (ASCE) rates nearly every category of national infrastructure as “poor.” Globally, it’s the same phenomenon.
The issue is that amid those low rankings include reduced Federal spending on infrastructure. While the Biden Administration did increase the quantity the Fed directly spent on critical infrastructure, this chart from Eaton Vance illustrates the continued downtrend of Federal infrastructure spending. The jump upward at the top of the chart was the spike on account of the Infrastructure Investment and Jobs Act (IIJA).
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Source: Eaton Vance
There still exists an enormous gap between what’s needed and what’s spent. The ASCE projects — based on optimistic models and the IIJA’s continued annual spending — a niche of nearly $2.95 trillion over the following decade. Remember, that is along with the estimated $7.3 trillion that’s projected to be spent.
There remains to be an enormous amount of money needed to construct out and maintain infrastructure.
Munis Come to the Rescue
For states and native municipalities trying to fill the gap, muni bonds have continued to turn into an ever-more essential piece of the pie. For instance, this yr alone greater than $250 billion of debt sold by state and native government borrowers has been earmarked solely for brand spanking new infrastructure developments. That’s a 30% increase over last yr, in keeping with Bloomberg data and Goldman Sachs.
Taking a look at the full, roughly two-thirds of critical infrastructure (e.g., roads, power grids, water systems, etc.) depend on municipal bonds/funding to be built and maintained.
That is interesting for investors.
For one, many investors simply ignore the elephant within the room. Despite being just 28% of the $3.8 trillion municipal bonds market, general obligation bonds (GOs) are the preferred amongst retail investors and are inclined to be what we expect of once we define municipal bonds. GO bonds are issued by state or local governments whose repayment is driven by these entities’ taxing authorities. Infrastructure-based revenue bonds are sometimes missed.
And, that’s an actual shame.
It is because revenue bonds could offer higher yields, higher credit profiles and potentially inflation-proof money flows.
Because the name suggests, the money flows of revenue bonds come from the revenues generated by the underlying project. For instance, paying a toll for using a bridge or a fee in your water bill to cover sewer charges. These revenues are strictly tied to the project, not California’s or Texas’s ability to tax its residents. These money flows can fluctuate based on usage and the way in demand the asset is. This offers them a lower credit standing than a GO bond, and that lower rating doesn’t necessarily increase risk.
Taking a look at credit rankings, 62% of all general government bonds, which incorporates GO bonds, are rated investment grade (Aa3 or higher), while only 41% of revenue bonds have that rating. As for defaults, GO bonds rarely go bust. Taking a look at all of the municipal bond defaults from 1970 to 2020, lower than 25% have been GO bonds. Nonetheless, once they do default, they go big. GO bonds were chargeable for over 75% of the dollar volume or value of all muni defaults. Meanwhile, recovery rates for a lot of revenue bonds are higher than those for GO defaults. That’s because there may be an actual asset that will be sold to recoup bond losses.
These aspects make revenue bonds less dangerous on a dollar-issued basis than GOs. At the identical time, they provide the next yield, which may include inflation-protected additional charges for patrons using the underlying asset.
Adding Some Infrastructure Bond Strength
With the necessity for greater infrastructure spending boosting the fortunes of municipal bonds and plenty of revenue bonds offering strong yields and great risk/reward tenants, it is smart to bet big on the sector.
There are two ETFs that directly bet on infrastructure-only revenue bonds: the Xtrackers Municipal Infrastructure Revenue Bond ETF (RVNU) and the Goldman Sachs Community Municipal Bonds ETF (GMUN). There may be also a closed-end fund, the BNY Mellon Municipal Bond Infrastructure Fund (DMB).
All three funds are tremendous. Nonetheless, assets and trading volume are low. A greater bet could also be considered one of the numerous high-yield muni bond ETFs on the market. Again, the majority of revenue bonds are for infrastructure projects. As such, the vast bulk of those fund’s holdings are infrastructure-based. And infrequently, high-yield munis are absent from a portfolio, with many investors considering the risks are high. Nonetheless, as we showcased and stated, that’s not necessarily the case.
High-Yield Municipal Bond ETFs
These funds were chosen based on their exposure to the high-yield municipal bond market. They’re sorted by their YTD total return, which ranges from 5% to 10.4%. They’ve assets under management between $80M and $3B and expenses between 0.32% to 1.98%. They’re currently yielding between 3.1% and 5.6%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| XMPT | VanEck CEF Muni Income ETF | $238M | 10.4% | 5.6% | 1.98% | ETF | No |
| HYMU | BlackRock High Yield Muni Income Bond ETF | $82M | 7.9% | 4.3% | 0.35% | ETF | No |
| JMHI | JPMorgan High Yield Municipal ETF | $175M | 6.4% | 4.3% | 0.59% | ETF | Yes |
| HYMB | SPDR® Nuveen Bloomberg High Yield Municipal Bond ETF | $2.52B | 6.3% | 4.3% | 0.35% | ETF | No |
| FMHI | First Trust Municipal High Income ETF | $573M | 6.3% | 4% | 0.70% | ETF | Yes |
| SHYD | VanEck Short High Yield Muni ETF | $328M | 5.3% | 3.1% | 0.35% | ETF | No |
| HYD | VanEck High Yield Muni ETF | $2.9B | 5% | 3.9% | 0.32% | ETF | No |
Ultimately, infrastructure development and municipal bonds go hand-in-hand. And yet, they are sometimes ignored by portfolios and investors. That’s an actual shame, as these bonds can offer quite a bit for portfolios including high yields and lower default rates.
Bottom Line
On the subject of raising capital for infrastructure, the municipal bond market is quickly becoming a go-to place for states and native governments. Trading on this market can offer substantial advantages for investors, including high yields, low default rates and robust interest payments based on money flow.