Recent developments suggest that municipal bonds may be on the verge of a resurgence, potentially benefiting exchange-traded funds (ETFs) like the ALPS Intermediate Municipal Bond ETF (MNBD). Despite lagging behind corporate bond indexes this year, munis could see an upswing due to anticipated changes in tax legislation. These changes might include raising the highest marginal tax rate, which could enhance the attractiveness of municipal debt, particularly for affluent investors in high-tax regions.
One of the primary factors influencing municipal bond performance is the ongoing debate over the 2017 Tax Cuts and Jobs Act. Concerns about its provisions have dampened investor sentiment toward munis. However, potential adjustments to the tax code, such as increasing the top tax bracket from 37% to 39.6%, could significantly boost the relative value of municipal bonds. According to LPL Financial, this change would elevate the taxable-equivalent yield-to-worst (YTW) of the Bloomberg Municipal Bond Index from 6.99% to 7.37%, surpassing yields offered by lower-rated corporate bonds.
Actively managed ETFs like MNBD are well-positioned to capitalize on current market conditions. With starting yields remaining attractive and tax-equivalent yields ranging from 7-9%, municipal bonds present a compelling investment opportunity, especially in the intermediate maturity category. While near-term volatility may persist, the fundamental strength of munis, including low default rates, adds to their allure.
Seasonality also plays a role in the muni market's dynamics. Historically, the summer months experience slower issuance, which could be advantageous given the recent surge in supply. Furthermore, municipal bonds generally exhibit superior default characteristics compared to corporate bonds. Since 1970, the 10-year cumulative default rate for investment-grade munis has been negligible, contrasting sharply with the over 2% rate observed in similarly rated corporate bonds. Lower-rated/high-yield munis also demonstrate a significantly lower default rate than their corporate counterparts.
The combination of favorable tax adjustments, attractive yields, and robust fundamentals positions municipal bonds and related ETFs like MNBD for potential growth. Investors considering these instruments should weigh the benefits of enhanced tax efficiency and historical resilience against broader market uncertainties.
