Bond traders have been preoccupied with the concept of "tight spreads" throughout the year. This implies that investors haven't been reaping significant rewards for venturing into bonds with higher risks compared to U.S. Treasurys. However, Steve McFee, a portfolio manager at Vanguard who specializes in municipal bonds, asserts that fixed income linked to local governments offers more appealing pricing along with tax advantages. He states, "The corporate credit market has been more prompt in responding to the favorable conditions for fixed income. Our market has been a bit slower. That's why I believe there is still ample potential in investing in credit munis."
Unlock the Potential of Municipal Bonds with Vanguard
Municipal Bond Basics
Municipal bond funds engage in the purchase and holding of fixed income instruments issued by state and local governments or affiliated entities. One of the primary benefits of these funds is that their income is typically tax-free. Investors should bear this in mind when comparing yields with other types of bond funds. Tax-equivalent yield represents the pretax yield that a taxable bond would need to generate to be on par with a municipal bond. For instance, an investor in the 32% income tax bracket holding a muni bond with a 3% tax-free yield would need to find a taxable issue with a 4.41% yield to achieve the same income level.During the Covid-19 pandemic, state and local governments were regarded as a relatively secure investment as federal relief and stimulus spending bolstered budgets across the nation. Even several years after the majority of those programs, the sector appears to be on a stable footing, as mentioned by McFee. He said, "Muni fundamentals remain resilient. We have witnessed a slight decline from the peak fundamentally when we saw stimulus flowing through the economy during Covid, but we are still fundamentally very strong."Opportunity in BBB-Rated Munis
McFee also highlights the opportunity in municipal bonds that carry a BBB rating. Although these issues are still classified as investment grade by credit agencies, they pose a slightly higher risk compared to munis with AAA ratings. This presents an interesting avenue for investors seeking a balance between risk and return.Municipal Bonds in 2024
In 2024, municipal bonds have emerged as a popular area for investment. Over the past month, major index funds like iShares National Muni Bond ETF (MUB) and Vanguard Tax-Exempt Bond ETF (VTEB) have attracted approximately $2.2 billion in combined inflows, as per FactSet. Year to date, this figure has expanded to more than $6.7 billion. The large iShares and Vanguard muni funds have each delivered around a 1.7% return year to date, compared to 1.6% for the iShares Core U.S. Aggregate Bond ETF (AGG). Moreover, Vanguard is not the only asset manager introducing new muni funds into the market. State Street, Goldman Sachs, and American Century are among the several firms that have launched muni ETFs in the second half of 2024.