Easier way to access municipal bonds

Most assets and asset classes suffered from red-hot inflation and aggressive moves by Central Banks to curb its effects, and municipal bonds are no exception. Spooked by the increasing price levels, investors withdrew investments worth billions from municipal bonds. The year's first half witnessed a record loss in the municipal bonds market, where yields for AAA-rated offerings (10-year and 30-year) rose about 1.7%. Industry experts expect this market segment to close in 2022 between 6.25% and 7.25% down.

Lately, more strategists on Wall Street believe that municipal bonds fell victim to an overreaction by investors. Institutional investors created a void as they’ve been exiting municipal bonds and the entire bond market, alarmed by volatility and inflation. Retirees are typically the ideal candidates for these fixed income securities due to their low credit risk and stable income – they are filling the void by returning to municipal bonds amid recession fears. State and local government finances in the United States also look healthy, adding to the rosy sentiment. This has recently resulted in several notable money managers becoming positive on municipal debt. 

Intro to Municipal Bonds  

The fixed income space is split into two main categories, investment and non-investment grade bonds, with investment grade bonds generally associated with higher quality. When approached differently, the same fixed income space can be sliced by issuer types such as corporate, supranational, government, government agencies, and municipal. A state issues the latter, a city, a county, or a municipality to fund day-to-day obligations and finance capital expenditures such as the construction of highways, bridges, schools, or sewer systems. In simple terms, an investor is lending money to a local government in exchange for a promise of regular interest payments and a principal amount.The biggest perk of investing in municipal bonds is their tax exemption status. They are often, not always, exempt from most federal, state, and local taxes, especially for residents, rendering them attractive to people in higher income tax brackets.

Municipal Bonds Types 

There are generally two common types of municipal bonds: 

1. General Obligation Bonds:  these issues are not secured by any assets. Instead, they are backed by the “full faith and credit” of the issuer, which holds power to tax residents to pay bondholders.
2. Revenue Bonds: issues falling under this category are backed by revenues from the funded projects. Some of them are referred to as non-recourse municipal bonds, where investors don’t have any claim on the underlying in case the revenue stream dries up.

Municipal Bonds Risk Consideration

Investments in municipal bonds entail numerous risks as much as investments in other assets and asset classes. For instance, some municipal bonds have embedded call options, giving the issuer the right to redeem the bond before the maturity date. In a decreasing interest rate, environment bond issuers are enticed to redeem their existing debt and reissue bonds at lower interest rates. In such a scenario, investors lose income from interest payments and face reinvesting in a bond with a lower return in what is known as call risk. Credit risk is another type of risk to consider when investing in municipal bonds. It reflects the possibility of the local government defaulting on its obligations, especially if it’s experiencing financial problems – a relatively rare event in the municipal bonds market.

Investors should be on the lookout for inflation, liquidity, and interest rate risks that they may face when investing in these types of debt securities. 

Municipal Bond ETFs

While many municipal bonds are rated by credit rating agencies as investment-grade, reflecting a relatively lower degree of credit risk, they are indeed not risk-free. Municipal bond exchange-traded funds helped spur more access to these bonds while reducing the risk by holding securities issued by a broad range of cities, states, municipalities, and local governments.  

Trackinsight’s Fixed Income ETF Screener identifies the Invesco US Municipal Bond UCITS ETF (MUNS) as the sole Europe-listed municipal bonds ETF with assets under management reaching USD$5.6 million[1] in 2022. It is passively managed by tracking the ICE BofA US Taxable Municipal Securities Plus Index. The index invests in a portfolio of taxable – nontax exempt – USD denominated fixed income securities issued by the U.S. states, territories, and their political subdivisions. Individual securities must be subject to U.S. federal taxes, have at least 18 months to final maturity at the time of issuance, and have at least one year remaining. They also have to be rated investment-grade, having a fixed coupon schedule. The 113 holdings are spread across different credit ratings holding 15.9% in AAA, 65.4% in AA, 7.9% in A, and 9% in BBB. MUNS is geographically concentrated in the United States, providing direct investments in U.S. municipal bonds. The fund costs 0.28% per annum to own while it follows a dividend distributing model where it distributes generated income to its shareholders. 

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[1] MUNS - Fund data as of July 15th, 2022.