Still, investors may have cause for optimism since yields on the bonds are rising and many state and local governments are financially flush.
The big perk of municipal bonds is that they are exempt from federal taxes.
But that benefit comes at a cost: Their yields are usually lower than those of comparable taxable bonds.
In May, the cost briefly disappeared, as the average yields on municipal bonds pulled even with those of U.S. Treasury securities. Investors were, in effect, enjoying municipal bonds’ tax benefits free.
Unfortunately, another cost loomed. Rising yields mean falling prices, as bond yields and prices move in opposite directions. So far this year, people who own municipal bond mutual funds and exchange-traded funds have seen the value of their investments sink.
As of June 30, the S&P Municipal Bond Index had lost about 8.4 percent this year, with the first quarter being especially doleful.
“Q1 2022 was the worst calendar quarter return for the municipal market in 40 years,” said Elizah McLaughlin, a municipal bond portfolio manager for Fidelity Investments.
A variety of factors contributed to those returns, but the biggest has been the Federal Reserve’s push to raise interest rates to fight inflation, Ms. McLaughlin said. The central bank has increased the short-term interest rate it controls three times so far this year, including an unusually large increase of three-quarters of a percentage point in June.
Fidelity’s Intermediate Municipal Income Fund lost 6.8 percent in the first half of the year and yields 2.6 percent.
Investors have responded to municipal bond funds’ woes by fleeing. About $75 billion was pulled out of funds tracked by Morningstar through the end of June, compared with inflows of about $62 billion for the same period in 2021.
But investors may now have reasons for optimism. For the first time in years, municipal bond yields are rising, and many state and local governments — the main issuers of these bonds — are financially flush and carrying strong credit ratings.
“Everyone expected state and local governments to suffer more from Covid than they did,” said Amanda Beck, an accounting professor at Georgia State University in Atlanta. “But they got a lot of federal relief money, and that made up for downfalls in revenue. Plus, property values didn’t fall, so tax revenues didn’t drop as much as was expected.”
The higher yields mean that municipal bond funds and E.T.F.s are providing better income than they have in quite a while.
“When you’re delivering 2 percent yields, it’s not fun for anybody, and the market was like that for a long time,” said Jim Murphy, head of the municipal bond team and a portfolio manager at T. Rowe Price. “I haven’t seen great value in the market in a long time, but I think the market now, with rates higher, is healthy.”
As of the end of June, T. Rowe Price’s oldest municipal bond fund, its Tax-Free Income Fund, was paying a yield of 3 percent, up from 2.4 percent at the end of December. A fund Mr. Murphy manages, a high-yield municipal offering that invests “a substantial portion of assets” in junk bonds, was paying 3.4 percent.
Vanguard called the surge this spring in municipal yields a “renaissance of tax-exempt income.”
Paul Malloy, head of municipal investments at Vanguard, said rising yields should benefit patient long-term investors.
“One of the things we see frequently in municipal markets is a herding effect and people chasing returns on the upside and then, on the downside, saying, ‘Oh, no, I better get out.’ That kind of market timing is something we constantly warn municipal investors against.”
Vanguard’s research has shown that people who jump in and out of markets often buy high and sell low, missing out on the returns they would have by staying invested.
Vanguard’s Tax-Exempt Bond Index Fund lost 8.6 percent in the first half of this year. The fund, which is also available as an E.T.F., yields 2.9 percent.
Municipal bonds are unusual in that they’re directly tax-subsidized: The income they produce is exempt from federal, and in some cases state and local, taxes. The higher your tax bracket, the greater the benefit.
Online financial calculators can help with comparing the yields on funds that hold taxable bonds versus municipal bonds.
As an example, imagine someone in the 32 percent federal tax bracket who is considering Vanguard’s Tax-Exempt Bond E.T.F. The fund’s tax-equivalent yield for that person would be 4.3 percent, meaning that a taxable bond fund would have to deliver a 4.3 percent yield to equal the E.T.F. after taxes have been accounted for. (Any applicable state and local breaks would increase the tax-equivalent yield.)
The tax breaks are one reason financial advisers like Peggy McGillin of Journey Wealth Partners in Concord, Mass., recommend holding municipal bond funds in the taxable portion of a portfolio. Keeping them in a tax-shielded retirement account wastes their tax benefits and locks in their lower stated yields. Ms. McGillin said her recommendations on allocation to municipal bonds vary based on the client’s age, income and wealth.
Costs always matter in investing, and low costs are one reason Sandi Bragar, chief client officer at Aspiriant Wealth Management, said she had recently been advising clients to put their municipal bond allocation in Vanguard’s Intermediate-Term Tax-Exempt Fund, which has an expense ratio of 0.17 percent. (The average municipal bond fund tracked by Morningstar has an expense ratio of 0.76 percent.)
Ms. Bragar says she prefers funds and E.T.F.s that invest nationwide, because of their greater diversification, over those dedicated to a single state like New York or California.
Even with a nationwide fund, an investor will end up with plenty of New York and California exposure because those states and their cities are big bond issuers, Ms. Bragar said. A resident of one of those states who bought a nationwide fund would receive some state and local tax relief because that person would receive credit for the fund’s investments in the relevant state, she said.
Like any investment, municipal bonds carry risks. A big one this year, of course, has been inflation. Another is that a big bond issuer falls into financial difficulty and defaults on its debt. This happened most recently with Puerto Rico, which filed for bankruptcy in 2017 after accruing about $70 billion in bond debt and $50 billion in unfunded pension obligations.
Now that Puerto Rico has emerged from financial reorganization with a plan to repay its creditors, some of its bonds are attractive, said Rachel Betton, a municipal bond portfolio manager for PIMCO.
“If you look at something like sales-tax-backed bonds, those have better legal protections than they did going into bankruptcy,” she said. “In general, we tend to like bonds coming out of restructuring. You’re being well compensated for the risks you’re taking.”
The A shares of PIMCO’s Municipal Bond Fund lost 10.7 percent in the first half of the year and yields 2.6 percent.
Complexities like the Puerto Rico bankruptcy and the vast variety of municipal bonds and their terms mean that actively managed municipal bond funds may have a good chance of outperforming indexed offerings, said Beth Foos, associate director for manager research at Morningstar. (On average, actively managed mutual funds don’t outperform indexed funds after their higher costs are accounted for.)
Ms. Foos said that information about municipal bonds can be hard to dig up and that disclosures by issuers are often spotty. As a result, the niche can reward an active manager’s research, she said.
When assessing an actively managed municipal bond fund, an investor should consider its team of managers and analysts — how many they number and their experience — as well as how the fund’s returns and income have held up in a variety of market conditions, she said.
No one, of course, knows what will happen to the municipal bond market or any market in the months ahead.
But Mr. Murphy of T. Rowe Price said states and municipalities have taken the financial steps needed for their bonds to remain prudent bets for investors.
“California is carrying a surplus,” he said. “New Jersey and Illinois, which were poster children for poor fiscal management, have improved. And a lot of states are closing the gap on their underfunded pension problems. That’s still an issue, but it’s probably been put off another decade.”
"poor" - Google News
July 15, 2022 at 04:00PM
https://ift.tt/JAzOVxt
It’s Been a Poor Year So Far for Municipal Bonds - The New York Times
"poor" - Google News
https://ift.tt/SMx6FOv
https://ift.tt/08vaZPq
Bagikan Berita Ini
0 Response to "It’s Been a Poor Year So Far for Municipal Bonds - The New York Times"
Post a Comment