With the brand new yr nearly 1 / 4 finished, quite a lot of trends and themes have already began to make themselves known. For the normally sleepy municipal bond sector, these trends have created a reasonably volatile and difficult environment to navigate. Tailwinds and headwinds have churned the seas of the normally calm waters of state and native government credit. There are crosswinds obviously.
For investors with big positions in muni bond holdings, reducing these stormy seas is paramount.
Luckily, there are methods to navigate these crosswinds and potentially finish the yr with some gains, all while collecting income. With these strategies in mind, munis can return to being a boring, income generator for a portfolio.
A Churning Sea
Municipal bond investors are a comparatively conservative lot. Bonds issued by state and native governments tend to not bounce around an excessive amount of and their investors sit back while collecting their coupon payments. With that in mind, the present muni environment is looking a bit rough.
Total returns for the fixed income asset class clocked in at positive 1.9% for all of 2024. Given the 4% yields on many muni bond indexes, that means the bonds’ prices managed to say no and yield/coupons managed to deliver the positive performance.
The explanations for the worth declines are a combination of economic and geopolitical issues.
For starters, municipal bonds may lose their tax-exempt status. Many lawmakers wish to expand portions of the Tax Cuts & Jobs Act because the bill sunsets this yr. Nonetheless, burgeoning deficits from the bill and potential tax cuts mean tax increases elsewhere might should be proposed. That has munis’ tax-exempt status now in query and potentially within the crosshairs. Given the uncertainty and quickly changing policy points the Trump Administration is understood for, many muni bond buyers and holders have begun selling.
At the identical time, tariffs and continued rising inflationary pressures have began to affect long-term bonds once more. The Federal Reserve might need to boost rates to combat the inflationary pressures. This has put munis under a further lens as they often have longer maturities and durations.
Issuances of muni bonds have also increased in recent quarters as many states have taken advantage of lower current rates to fund their balance sheets and issue debt more cheaply.
And yet, these headwinds have been met with some very strong tailwinds propelling the muni sector.
That features among the highest starting yields in years. In response to investment manager and muni bond specialist, Nuveen, municipal yields began 2025 at the very best level in nearly 15 years. Straight away, muni bonds are yielding 122 basis points above their 20-year trailing average.
Furthermore, the after-tax yield is substantially higher versus Treasury bonds, even when we were to account for taxes in that yield and the potential for the sector to lose its tax-exempt status. This chart from Goldman Sachs highlights the spread.
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Source: Goldman Sachs
Then there’s the state’s health as well. Balance sheets and rainy-day funds are still robust, while prudent budget management has continued to repay. This has enhanced the credit quality of muni bonds.
Calming the Waters
So, on the one hand, muni investors have faced potentially nasty woes across tax status, geopolitical issues, and rising inflationary pressures. Alternatively, they’re currently offering among the fattest yields and strongest credit profiles in nearly twenty years. Attempting to balance the positives of the sector versus among the negatives is a effective line to walk. But there are methods to try this.
In response to AllianceBernstein, there are 4 strategies investors can follow to navigate the crosswinds and add ballast to their municipal bond boat.
The first step could possibly be to selectively extend your duration. By going out on the yield curve, investors can make the most of falling yields once they come or help clip more income today. If things right themselves and the Fed can once more start cutting rates as originally predicted, bond prices on the long end of the curve will rise. In the event that they are forced to maintain rates the identical for some time, investors can clip more income from these bonds.
But by going long, investors are exposed to duration risk. That is why AllianceBernstein also recommends a barbell strategy, which mixes short- and long-term maturity bonds. This enables investors to have their cake and eat it too. The short-term bonds protect against rising rates, while the long-term bonds protect against falling. In response to AllianceBernstein, a barbell strategy would have market-beating returns last yr.
Third, investors should look beyond investment-grade munis for returns. The high-yield market has long been a source of outsized yields at only barely higher-risk profiles. Non-investment grade, BBB-, and A-rated bonds currently have yields of nearly 6%. Nonetheless, many so-called high-yield munis still offer strong credit profiles and extra riders for repayment.
Finally, AllianceBernstein recommends staying flexible. The connection between high-grade municipals and U.S. Treasuries is commonly changing. This relationship has long signaled great items to purchase munis for strong total returns. Being more lively together with your muni bond portfolio could repay and supply a method to lower volatility in the brand new yr.
Navigating the Crosscurrents
Given the strong yield appeal and potential for gains, munis are still a top draw. But investors must work toward navigating the headwinds. Following AllianceBernstein’s advice and using duration as a tool, in addition to being selective in credit, barbelling, and timing purchases, makes a number of sense. Luckily, there are many ways to attain a portfolio under this framework. ETFs could make short work of this.
For instance, the VanEck Long Muni ETF and SPDR Nuveen Bloomberg Short-Term Municipal Bond ETF could possibly be paired for a barbell strategy. An lively ETF could possibly be used to search out opportunities, while investors could obese a high-yield muni ETF to achieve credit exposure. The thought just isn’t to be static and easily buy a broad muni index and ride out the waves.
Lively Municipal Bond ETFs
These ETFs were chosen based on their ability to offer low-cost and lively exposure to the municipal bond market. They’re sorted by their YTD total return, which ranges from 0.4% to 1.6%. They’ve expense ratios between 0.12% and 0.65% and assets under management of $128M to $2.6B. They’re currently yielding between 2.5% and 4.4%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| SHYM | iShares High Yield Muni Income Lively ETF | $295M | 1.6% | 4.4% | 0.46% | ETF | Yes |
| CGMU | Capital Group Municipal Income ETF | $2.59B | 1.2% | 3.4% | 0.27% | ETF | Yes |
| MUNI | PIMCO Intermediate Municipal Bond Lively ETF | $1.75B | 1.2% | 3.2% | 0.35% | ETF | Yes |
| SMMU | PIMCO Short Term Municipal Bond Lively ETF | $630M | 1.2% | 2.9% | 0.35% | ETF | Yes |
| IMNU | iShares Intermediate Muni Income Lively ETF | $244M | 1.2% | 3.6% | 0.30% | ETF | Yes |
| MEAR | iShares Short Maturity Municipal Bond Lively ETF | $733M | 1% | 3.1% | 0.25% | ETF | Yes |
| VCRM | Vanguard Core Tax-Exempt Bond ETF | $128M | 0.8% | 3.1% | 0.12% | ETF | Yes |
| DFNM | Dimensional National Municipal Bond ETF | $1.42B | 0.7% | 2.5% | 0.19% | ETF | Yes |
| FMB | First Trust Managed Municipal ETF | $2.04B | 0.6% | 3.3% | 0.65% | ETF | Yes |
| TAXF | American Century Diversified Municipal Bond ETF | $508M | 0.4% | 3.6% | 0.29% | ETF | Yes |
Passive Municipal Bond ETFs
These funds were chosen based on their exposure to municipal bonds at a low price. They’re sorted by their YTD total return, which ranges from 0.2% to 1.1%. They’ve expense ratios between 0.03% and 0.35% and assets under management between $2.8B and $42B. They currently offer yields between 2.7% and 4.4%.
| Ticker | Name | AUM | YTD Total Ret (%) | Yield (%) | Exp Ratio | Security Type | Actively Managed? |
|---|---|---|---|---|---|---|---|
| SHM | SPDR Nuveen Bloomberg Short Term Municipal Bond ETF | $3.65B | 1.1% | 2.7% | 0.20% | ETF | No |
| HYMB | SPDR Nuveen Bloomberg High Yield Municipal Bond ETF | $2.86B | 0.9% | 4.4% | 0.35% | ETF | No |
| MUB | iShares National Muni Bond ETF | $41.1B | 0.2% | 3.2% | 0.05% | ETF | No |
| VTEB | Vanguard Tax-Exempt Bond ETF | $39B | 0.2% | 3.3% | 0.03% | ETF | No |
All in all, the municipal bond sector has loads of potential, but in addition loads of headwinds. For investors, navigating those issues can result in loads of strong returns because the market plays out. By being selective, barbelling, and searching at credit opportunities, investors can profit from the present muni sea and win.
The Bottom Line
Municipal bonds have been pretty volatile over the previous couple of months. And most of the trends creating that volatility haven’t stopped. But investors shouldn’t surrender hope. There are methods to play the muni market and profit.