Viewpoint on Municipal Bonds
With Peter Hayes
Municipal bonds have done well despite heightened volatility in markets broadly and bankruptcy chatter in the muni space specifically. BlackRock muni pro Peter Hayes answers key questions on investors' minds.
What has been drawing investors to munis?
First, investors are looking for income in a low-rate world, and munis are providing attractive relative yields. Munis have outyielded Treasuries before tax for most of 2012, making them even more appealing on an after-tax basis. Second, munis have displayed much lower volatility than both Treasuries and equities through most cycles over the past 2-3 years. Overall, tax-exempts continue to offer yield, income and capital preservation at a time when each is highly prized.
Given the voracious demand, why is supply up?
We've actually had a rare net negative supply scenario for 2011 and much of 2012. Notably, almost two-thirds of issuance this year is refunding issues. That means issuers are calling or refinancing bonds issued at higher interest rates and replacing them with bonds at lower rates. Investors, in turn, support these new issues with their proceeds from bond maturities or coupon payments. So it creates its own balance.
How will potential tax policy changes affect munis?
We still need clarity, but I can say this: Munis are one of the only areas of the market that would benefit from an increase in tax rates. The tax-advantaged nature of the asset class would draw the attention of an even broader investor base.
Are munis in danger of losing their tax-exempt status?
Loss of tax exemption seems highly unlikely, and even the idea of limiting that benefit would be difficult for lawmakers to pass. To the extent munis become part of the broader tax-reform conversation, we'd still expect limited market impact given the offset of higher marginal tax rates.
And what about the cries of bankruptcy risk?
Importantly, none of the bankruptcy cases since 2007 has taken the market by surprise and most have had less to do with the recession and more to do with fiscal mismanagement and unfortunate decisions over time. While local bankruptcies may trend modestly higher versus historic norms, we do not foresee widespread risk.
Managing Director, Head of Municipal Bonds Group
Investment involves risks. Stock and bond values fluctuate in price so the value of your investment can go down depending on market conditions. The two main risks related to fixed income investing are interest-rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to Alternative Minimum Tax (AMT). Capital gains distributions, if any, are taxable. Investments in non-investment-grade debt securities (high yield or "junk" bonds) may be subject to greater market fluctuations and risk of default or loss of income and principal than securities in higher rating categories.
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