INSIGHTS

On June 16, 2014

Viewpoints from AAM - 4 Reasons Why Municipal Bonds Are In Demand by Investors

1. Higher Credit Quality


Much has been written about the low rate of defaults on investment-grade municipal bonds. Although there are exceptions, many feel that states and municipalities overall are in better shape now than five years ago. Governments have reduced staff, cut expenses and generally have gotten their fiscal house in order while overall revenues have begun to recover. Yes, there are defaults, but many of those defaults are on lower rated or below investment-grade issuers. According to a Moody’s default study in 2013, municipal defaults averaged 0.012% over a 43-year study of investment-grade municipal bonds. Consult your investment advisor; they can help steer you to a higher quality rated bond.

There are many individuals in retirement or approaching retirement age. Many of these investors want higher quality fixed income bonds that they are confident will return the principal at maturity. I am all for unconstrained, alternative fixed income investments and I recently wrote a blog extolling the virtues of nontraditional income producing investments. What I am saying is that a lot of retirement type or soon-to-be-retirement-type investors want at least a portion of their income-producing investments in traditional fixed income bonds, whether tax-exempt municipal bonds or taxable corporate bonds, where they are more comfortable with the likelihood that their principal is relatively safe on an historical basis.

Yields on municipals are still attractive. The often-quoted AAA municipal yield on a 10-year maturity stands at around 90% (10-year Treasury bond at 2.60% yield and the 10-year AAA municipal yield at a 2.33% tax exempt yield) which historically has signaled a compelling value. In fact, the yield on a single A-rated municipal bond is higher by 0.5% to 0.75% than the above-referenced AAA yield.

4. Federally Tax Exempt

Municipal bonds are federally tax free, not to mention that they can also be state and local tax exempt. If you are in the camp, as many are, that federal tax rates are going to go up, then current interest rates received on tax-free municipal bonds could be even more attractive. If federal tax rates do rise, the interest rates on new issue tax free municipal bonds will probably decrease to adjust to the new tax metrics and align with the taxable markets. The tax-exempt status municipal bonds offer appeals on many levels to investors; a potential tax increase just being one of them.

As a caution, I am speaking to the current rate environment and the relative value of the municipal bonds today. There is interest rate risks involved with any fixed income investments and if rates rise, bond values drop. This is the risk most investors are concerned about. Your financial advisor can give guidance on this topic. The point here is that today municipal bonds can offer good relative value and are worthy of a discussion with your financial advisor on how they may fit in your portfolio.

CRN: 061214-4240R

An investment in Municipal Bonds is subject to numerous risks, including higher interest rates, economic recession, deterioration of the municipal bond market, possible downgrades, changes to the tax status of the bonds and defaults of interest and/or principal. A bond’s call price could be less than the price paid for the bond. Bonds typically fall in value when interest rates rise and rise in value when interest rates fall. Bond insurance covers interest and principal payments when due and does not insure or guarantee the value of any bond in any way.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Municipal Disclosures webpage. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com