A quick case for taxable muni bonds
MARK CLAYTON, CFA 11-Jun-2019
With issuance of taxable municipal bonds on the upswing, there is a growing investment opportunity for taxable buyers that focuses on potentially higher yields and lower credit risk. Taxable munis may also help diversify a fixed-income portfolio.
Normally, taxable munis have accounted for a modest share of the overall municipal bond market, which is dominated by tax-exempt issuance. However, supply has increased due to a low rate environment and federal tax law changes limiting use of tax-exempt bonds for advanced refunding purposes. Taxable munis have now become an economically viable alternative to refund higher-coupon tax-exempt debt prior to its call date.
Taxable munis have recently offered additional yield relative to similarly rated corporate bonds, driven by increased supply and a slight liquidity premium.
In addition to higher yield, taxable municipal bonds tend to carry a lower credit risk than comparable corporates. They are typically backed by taxing authority or dedicated revenue streams from essential services.
A report by Moody’s Investor Services for the 10-year period from 2009-2018 found that the cumulative default rate for investment-grade munis was less than 0.2%, compared to 1.2% for global corporates. For speculative-grade bonds, the default rate for munis over the 10 years was 12.4%, while the corporate default rate was 22.1%.
Taxable municipal securities can also provide additional diversification, given that taxable portfolios generally have little exposure to state and local governments, universities or other nonprofit entities.