Financial Industry Insights from Advisors Asset Management


AAM Viewpoints – Year-End Municipal Checklist

Whether we like it or not, the month of December is often all too synonymous with to-do lists. Checklists that are full of presents to buy, groceries for hosting holiday get-togethers, and items to pack for a family winter vacation all remind us of how truly hectic it can get during the winter holiday season. Within the realm of financial markets, astute investors are tasked with yet another fundamental to-do list that, in our opinion, needs to be addressed at the very least once before year-end, especially if their assets are not professionally managed. Despite its alleged reputation as a low volatility “buy and hold” asset class, we believe tax-exempt municipal bond portfolios should not take exception to an actively-managed approach that includes the following year-end tasks:

Evaluate Existing Portfolios

Earlier in the year, municipal (“muni”) yields hit historic lows as the 30-year AAA municipal benchmark dipped below the 2.0% mark. Additionally, while an inverted municipal curve occurs much less frequently than its taxable counterparts, the six-year AAA municipal was yielding less than a one-year municipal at one point. Despite their chronic and severe underfunded pension liabilities, Illinois and New Jersey have been among the top performing states of the market, both outperforming the muni aggregate composite by well over 100 basis points through the end of November. All in all, these unforgiving market conditions have collectively made it difficult for investors to source value and have likely compromised investment strategies to accommodate the never-ending demand for yield.

Since the end of the 3rd quarter of 2019, some of these tight trading conditions have loosened moderately, arguably giving municipal investors a few more options to work with. At this point, we think that investors should take this short window of opportunity to re-evaluate their portfolio holdings and investment parameters. Here are some questions that we believe are worth asking:

  1. What are the weakest credits in the portfolio? Which bonds might be subject to a downgrade in the event of an economic downturn? Which bonds have benefited from this year’s rally and might appear overvalued?
  2. Is the portfolio adequately diversified? Is it overexposed to a specific region, state, or maturity?
  3. Has portfolio duration drifted too far below target? Are there any short maturities or pre-refunded securities that could be sold (at a lower give-up yield) to facilitate a swap trade for the purpose of servicing duration and/or capturing a higher yield?

Please be mindful that should any of these questions prompt an action, a trade does not necessarily need to be executed immediately. Assuming the portfolio does not hold a security that is imminently at risk of a default, there should be more favorable market conditions to sell bonds in the coming weeks of the new year due to higher demand/lower supply patterns (most notably known as the January Effect).

Assess Tax Opportunities

It goes without saying that investors need to carefully assess the tax implications of particular portfolio-enhancing trades, especially if they are also interested in harvesting tax losses during the final weeks of the calendar year. Unlike Treasuries, Agencies, and most investment grade Corporate bonds that generally trade at tighter bid-ask spreads all year round, we believe municipal bond investors might be best served by realizing capital losses sooner than later as trade volumes typically drop off toward the latter half of December.

That said, with the S&P 500 up nearly 25% year-to-date and the Bloomberg Barclays U.S. Aggregate Bond Index returning 8.79% through 11 months of the year, investors may be hard pressed to find substantial tax-loss opportunities in their investment portfolios in 2019. However, given the modest rise in yields so far during the fourth quarter, fixed income investors may have short-term unrealized losses in their portfolios if purchases were made when rates were at or near their lows earlier in the year. Either way, we believe tax-conscious investors should weigh the pros and cons of a sale, especially if the loss is relatively inconsequential in amount or if the investor believes it may be difficult to replace the give-up yield of the sale at a later date.

Regarding the reinvestment of the sale proceeds, please note that municipal bonds are also subject to the Wash-Sale rule, which essentially negates the realized loss if violated. In short, the safest way to avoid the Wash-Sale rule is to wait 30 days before reinvesting. If waiting is not an option, a municipal investor can buy a bond where at least two of the following three characteristics are different from the one that was sold: its bond issuer, coupon, or maturity date.

Review Market Outlook and Investment Expectations

Having a broad understanding of how the market performed during the past year as well as what muni pundits expect for the future can help municipal bond investors adjust their expectations of the tax-exempt asset class for the new year. Through November 2019, the aggregate municipal bond market is up 7.21%, its highest return in four years. Municipal issuers and underwriters expect to come to market a lot more than they did in 2019, which seems to suggest that there should be more investment options for investors looking to clip tax-free income. With the broad U.S. economy growing (albeit at a slower rate versus a year ago), it wouldn’t be a stretch to see rates moderately rising further from current levels. However, the fact that trade negotiations are still unresolved, an estimated $12 trillion of sovereign debt is still in negative territory (as of early December 2019), and the United States is entering a Presidential election year all have the potential to disrupt normal market dynamics and continue to direct even more record inflows into municipal asset class in 2020.

While a few tasks on this to-do list might seem like common practice for some, there’s no question that these responsibilities all require time to see through to completion. Regardless of what needs to be done this month, we believe that we can all agree that no time is better spent than time with our family and loved ones – Happy Holidays!


CRN: 2019-1209-7855 R

Advisors Asset Management, Inc. and its representatives do not provide tax advice.

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 the trust 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 Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit


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