- Use the services of a municipal securities dealer, such as a broker-dealer or a bank department. A private client broker is a broker who primarily deals with individual investors at a full-service broker-dealer, though they may also be referred to as “financial consultant” or “financial adviser.” The investor must make an explicit order to buy or sell securities in a brokerage account, and purchases and sells of municipal bonds through a broker-dealer must be preceded by a discussion with the investor.
When selling municipal securities, broker-dealers, like all other forms of investment alternatives, have particular responsibilities to investors. For example, when an investor buys or sells a municipal security, a broker-dealer must provide all material information about the investment to the investor and must give a fair and reasonable price. Full-service When broker-dealers buy or sell bonds for investors, they charge a fee. Broker-dealers that act “as principal” (that is, facilitate trades through their own inventory) charge a “mark-up” when selling bonds to investors and a “mark-down” when buying bonds from investors. The fee is called a “commission” when broker-dealers act “as agent” (that is, when they help identify a buyer or seller who deals directly with the investor). The MSRB pamphlet contains useful information on mark-ups and mark-downs, as well as other fees that brokers may charge.
- Engage the services of an investment adviser who can identify and trade bonds based on your specific or broad instructions. A registered investment adviser (RIA) manages accounts and acquires and sells securities in line with an investor’s agreed-upon plan without requiring individual consent for each transaction. When you engage an RIA, you should receive written paperwork that specifies both your account’s investment policy and the RIA’s investment procedure. To get a better price, RIAs frequently bundle purchases for multiple clients by trading in larger blocks. Account holders are frequently charged a management fee by RIAs. Some advisers price differently based on the interest rate environment and the interest profits that come with it.
- A self-managed account allows you to trade straight online. Another alternative for investors who wish to purchase and sell muni bonds on their own is to use a self-managed account, commonly known as “direct online trading,” which allows them to do so without the help of a private client broker or RIA. This is a broker-dealer account that charges commissions, mark-ups, and markdowns just like a full-service brokerage account. The firm has the same responsibilities to investors as any other broker-dealer, but it may perform them in a different way. For example, disclosure regarding a certain bond could be done only through electronic means, with no interaction with a private client broker. A self-managed account necessitates that the investor comprehend the benefits and drawbacks of each transaction.
- Purchase or sell municipal bond mutual fund shares. Another approach to engage in the municipal bond market is to purchase shares in a mutual fund that invests in muni bonds. Municipal bond mutual funds, which invest entirely or partially in municipal bonds, can be a good method to diversify your portfolio. While municipal bond funds can provide built-in diversification, you do not own the bonds directly. Instead, you hold a piece of the fund’s stock. This is significant because interest rate fluctuations have a different impact on municipal bond mutual fund owners than they do on direct municipal bond owners. Many investors who purchase individual municipal bonds aim to retain them until they mature, despite the fact that bond market values fluctuate between purchase and maturity. Mutual fund managers, on the other hand, are aiming for a stable or rising share price. If rising interest rates cause the market value of bonds in a mutual fund’s portfolio to drop, some of those bonds will be sold at a loss to avoid additional losses and pay for share withdrawals. You are subject to potential swings in the mutual fund’s value as a mutual fund stakeholder.
- Purchase or sell municipal bond exchange-traded funds (ETF). ETFs are a hybrid of mutual funds and traditional equities. The majority of municipal bond ETFs are structured to track an index. The share price of a municipal bond ETF can fluctuate from the ETF’s underlying net asset value (NAV) because it trades like a stock. This can add a layer of volatility to the price of a municipal bond ETF that a municipal bond mutual fund does not have. When an investor buys or sells shares of a municipal bond ETF, the transaction takes place over the exchange between investors (buyers and sellers). When an investor buys or sells shares in a municipal bond mutual fund, on the other hand, the transaction is handled directly by the mutual fund company. Municipal bond ETFs trade like stocks during market hours. A single purchase or sale of municipal bond mutual funds is permitted per day.
Expenses for mutual funds and ETFs include sales commissions, deferred sales commissions, and a variety of shareholder and running fees. FINRA’s Fund Analyzer allows you to compare fund fees and expenses.
Regardless of how you participate in the municipal bond market, the MSRB advises that you think about your investment needs and get written information from your financial professional regarding how fees are charged and which costs apply to your account before investing in a muni bond.
How much cash do I require to purchase municipal bonds?
Municipal bonds are different from corporate bonds in that the interest they pay is taxed differently, and they have lower default rates. Municipal bonds have lower yields than comparable corporate bonds because of this. Furthermore, municipal bonds often require a $5,000 minimum investment, whereas corporate bonds begin at $1,000.
In short, munis and corporate bonds have different risk-reward profiles. If you want to take on less risk, municipal bonds are the way to go; if you want greater yields but are willing to take on more risk, corporate bonds are the way to go.
Are municipal bonds currently a good investment?
Municipal bonds have attracted a lot of money from investors looking to decrease risk and taxes. Some investors may be concerned about price drops as the Federal Reserve seeks to raise interest rates. However, muni bonds may see higher coupon rates, and a well-constructed portfolio can still meet long-term objectives, according to financial experts.
Is it wise to invest in municipal bonds in 2022?
The municipal market enters 2022 with a strong credit foundation and a favorable technical environment. However, the rate of credit improvement is expected to decelerate in 2022, and weaker demand and greater bond supply are more likely in 2022 than in 2021.
Low default rates, an upward ratings bias, substantial revenue growth, extensive federal backing, and recovering pension funds characterize the credit market. The credit issues presented by the Omicron version are doable. However, given emerging risks such as climate change, inflation, labor shortages, disruptions in public schools, a more entrenched remote work culture, and a return to a less reliable federal funding environment, the favorable credit environment could deteriorate later in the year, especially if Republicans retake the House or Senate in the November 2022 midterm elections.
In terms of market technicals, the year 2021 was marked by robust municipal bond fund inflows (demand) and limited supply growth. In 2021, strong inflows combined with a restricted supply of tax-exempt bonds resulted in historically low ratios and narrow credit spreads.
In 2022, we don’t expect any notable changes in ratios or spreads. Higher tax rates are still being debated in Congress, and the increased money supply is unlikely to grow significantly. If the Federal Reserve (Fed) raises rates as expected, issuers continue to see value in tax-exempt refundings and taxable advance refundings, and the market endures bouts of outflows and weak demand, periods of somewhat reduced demand and greater supply are possible. In short maturities, we prefer assuming a little more credit risk and opportunistic buying if ratios or spreads widen.
What are the economic benefits of financing with municipal bonds?
- Municipal bonds are typically used to fund capital projects rather than recurring expenses (such as salaries or government benefits).
- Schools, acute care hospitals, roads, highways, and bridges; airports; subways; seaports and marine terminals; water and wastewater facilities; multi-family housing; libraries and town halls; electric power and natural gas equipment for city-owned utilities; and other public projects are all included in these investments.
- In the last decade, $2 trillion in infrastructure construction has been financed with tax-exempt municipal bonds. 1
- Municipal bonds account for over two-thirds of the nation’s essential infrastructure. 2
Who buys municipal bonds?
- Individuals own about 72 percent of bonds, either personally or through mutual funds and other vehicles.
- Households with incomes of less than $200,000 receive roughly 40% of municipal bond interest. 4
- Businesses, particularly property and liability and life insurance companies, but also banks, own about 25% of bonds.
Why do investors buy municipal bonds?
- The municipal bond market is known for its stability, which attracts investors.
- Bonds have been issued by state and municipal governments for centuries, and they are a well-known and well-regulated financial tool.
- Investors benefit from the exclusion of interest from federal income tax.
- Investors, on the other hand, accept a reduced rate of return on the bond in exchange for the tax benefit, which reduces or eliminates any tax “windfall.”
What are the financial benefits of financing with municipal bonds?
- Municipal bond-financed projects cost $495 billion less in the last decade than taxable debt-financed projects. 6
How do bonds promote fiscal responsibility?
- Bonds are approved by a voter referendum or a governmental body’s affirmative vote (a city council, county council, utility board, or the like).
- While the federal debt has nearly doubled in real terms and as a percentage of GDP over the last decade, state and municipal debt has stayed constant. 7
In 2021, are municipal bonds a decent investment?
- Municipal bond interest is tax-free in the United States, however there may be state or local taxes, or both.
- Be aware that if you receive Social Security, your bond interest will be recognized as income when determining your Social Security taxable amount. This could result in you owing more money.
- Municipal bond interest rates are often lower than corporate bond interest rates. You must decide which deal offers the best genuine return.
- On the bright side, compared to practically any other investment, highly-rated municipal bonds are often relatively safe. The default rate is quite low.
- Interest rate risk exists with any bond. You’ll be stuck with a bad performer if your money is locked up for 10 or 20 years and interest rates climb.
Do you have any experience with municipal bonds?
Residents of the issuing state are generally excluded from federal and state taxes on income earned from municipal bonds. While interest income is tax-free, any capital gains delivered to the investor are taxable. The Federal Alternative Minimum Tax may apply to some investors’ earnings (AMT).
What will happen to bonds in 2022?
- Bond markets had a terrible year in 2021, but historically, bond markets have rarely had two years of negative returns in a row.
- In 2022, the Federal Reserve is expected to start rising interest rates, which might lead to higher bond yields and lower bond prices.
- Most bond portfolios will be unaffected by the Fed’s activities, but the precise scope and timing of rate hikes are unknown.
- Professional investment managers have the research resources and investment knowledge needed to find opportunities and manage the risks associated with higher-yielding securities if you’re looking for higher yields.
The year 2021 will not be remembered as a breakthrough year for bonds. Following several years of good returns, the Bloomberg Barclays US Aggregate Bond Index, as well as several mutual funds and ETFs that own high-quality corporate bonds, are expected to generate negative returns this year. However, history shows that bond markets rarely have multiple weak years in a succession, and there are reasons for bond investors to be optimistic that things will get better in 2022.
Opportunity cost
Municipal bonds’ tax advantages aren’t as valuable if you’re in a lower tax band as they are if you’re in a higher tax bracket.
If that’s the case, you could be better off putting your money into alternative investments for a larger return.
They may not be liquid
If you need money quickly, you should be aware that municipal bonds may have liquidity problems.
You might not be able to find an active market for your bonds, which means you won’t be able to sell them when you want at the price you want.
Why are municipal bonds falling in value?
Some economists predict a reduction in muni demand this year due to a predicted slowing in household savings, which grew during the pandemic, particularly among the wealthy. The demand for tax-exempt debt has long outstripped annual issuance.
How are municipal bonds faring?
In terms of performance, new issuance, and investor demand, the municipal bond market had a strong year. This achievement is all the more remarkable given that it occurred at a time when inflation was rising, interest rates were rising, and the epidemic was still going strong.
On the technical side, new issuance increased by about 15% in 2021, reaching a new high of $316 billion. Furthermore, fund flows were positive in 51 of 52 weeks, reaching more than $100 billion, a new high. As a result, the supply of fresh issues was rapidly consumed, and oversubscriptions were common.
Since mid-2020, the fundamental credit quality of municipalities has been improving. Municipal issuers, such as state and local governments, airports, public transit systems, hospitals, and schools, received $1.25 trillion in the four key stimulus acts. Furthermore, state government revenues have more than recovered, increasing by 21% and coming in 19% higher than pre-pandemic levels. Only 30 downgrades were given by Moody’s in the third quarter, compared to 115 upgrades.
In comparison to other fixed income asset classes, high quality municipals performed consistently in 2021, with minimal volatility and less interest rate sensitivity. Munis have only displayed 32% of the volatility of US Treasury bonds in the 30-year area of the yield curve, and only 22% in the 5-year segment. For the year, the S&P Main Index (AA-range average credit quality) returned 1.77 percent.
Credit spreads narrowed by 80 basis points over the equivalent-maturity AAA bond this year, from 265 to 185 basis points. This resulted in high yield outperforming investment grade by a significant margin. In 2021, the S&P Municipal High Yield Index returned 6.82 percent, outperforming the market by more than 500 basis points. BBB spreads fell from 108 basis points to 63 basis points in 2021, indicating a narrowing of lower investment grade spreads.
Municipal-to-Treasury yield ratios are still low by historical standards. The 10-year municipal-to-Treasury yield ratio started the year at 76 percent, matching its historical average, but fell to 68 percent at year’s conclusion. Although this is a long way from its tightest levels in 2021, it still demonstrates the asset class’s resilience in this portion of the curve. 30-year ratios, which are normally less expensive than 10-year ratios, fell to 78 percent at the end of the year, compared to a long-term average of 93 percent.
The supply of new issues fell marginally from 2020 to $358 billion, but the composition was very different. Refinancings fell by 24 percent, but new capital issuance increased by approximately 15 percent to $316 billion.
Taxable municipal supply fell by 20% for the year, but it is still a far larger part of the total market than it was before the Tax Cuts and Jobs Act of 2017. Taxable munis accounted for 30% of the new issue market, with over $140 billion in new issuance.
In terms of fresh issuance in 2022, there is a lot of uncertainty. For both tax-exempt and taxable municipal borrowers, interest rates and spreads are now attractive. If rates rise rapidly, though, this attractiveness will alter. Furthermore, because state and local governments are flush with federal stimulus funds and record revenue receipts, projects might be funded without incurring new debt. Rising rates, on the other hand, may not deter issuance because infrastructure improvements need significant money, and increased revenues provide borrowers confidence to take on new debt.
Forecasts for new issuance in 2022 range from $400 billion to $520 billion, with a median of $470 billion. Moderate growth from last year’s level appears to be the most likely scenario.
In 2021, municipal mutual fund flows were constantly positive, with investor demand increasing 51 times out of 52 weeks. In October, November, and December, open-end mutual funds received $1.94 billion, $4.84 billion, and $2.34 billion, respectively. The annual total was roughly $71 billion through November. Municipal exchange-traded funds increased at a quicker rate than mutual funds on a percentage basis, hence this total understates interest in the asset class.
In October, November, and December, high yield municipal fund flows were -$264,000, +$2.60 million, and +$2.28 million, respectively. Annual fund flows were also strong in November, totaling roughly $20 billion.
Payment defaults totaled $2.1 billion in 2021, down 19 percent from the previous year. This is still a relatively modest portion of the $4 trillion market. Nursing homes and revenue bonds for industrial development continue to account for over 75% of all municipal defaults in 2021. Prior to the pandemic, these groups contained among of the most idiosyncratic risks in the municipal market, and they accounted for a large share of overall new defaults. In most cases, the defaults cannot be explicitly linked to pandemic consequences, however this may change in the future. We do not believe that municipal payment defaults will become prevalent.
Outlook
The municipal bond market, like the rest of fixed income, is facing headwinds. With a tighter labor market and stubborn inflation, the Fed may be able to accelerate the end of QE and start raising rates sooner than expected. Furthermore, fiscal stimulus should be reduced drastically.
- The US economy is doing well on its own, which means less monetary and fiscal assistance is required. The federal deficit in the United States has been drastically reduced as a result of this normalization process compared to the previous year.
- Municipal cash and revenue levels are at all-time highs, with credit trends in most sectors going in the right direction.
- Demand for both taxable and tax-exempt municipals is outstripping new supply, indicating that liquidity is strong.
- Potential new federal government initiatives that could have an impact on the municipal market have seen a significant decrease in volatility.
Overall, we think it’s a good idea to take advantage of the upward momentum in municipal credit, which has had little association with Treasury rate movements. We would see this as a chance to buy into weakness and higher yields if Treasury market volatility has a negative influence on municipals at key periods this year.
- Although the Federal Reserve is focused on controlling inflation, the course of inflation will be a wild card in 2022.
- The Federal Reserve has expedited the pace of tapering in order to end it earlier in 2022, and it has hinted at a first rate hike as early as March. This year, there could be as many as four rate hikes, with more hikes predicted until 2024.
- Although the economy has reached its peak, growth remains strong as the economy returns to normalcy.
- The $1.2 trillion Infrastructure Bill was passed in late 2021 with some cuts. More fiscal stimulus is possible, although at a far lesser level than in the previous two years.
- The net supply of tax-exempt municipals may be restricted, but demand has easily absorbed supply. The taxable municipal supply is expected to be strong, following the same trajectory as in 2021.
- Municipal credit has rebounded strongly since the downturn, bolstered by greater tax receipts and trillions of dollars in federal assistance.
- COVID-19 and its variants can have an influence on global growth, while outbreaks in the United States are less likely to trigger widespread shutdowns or have a negative impact on municipal credit.
- We predict high yield municipal bonds to continue to outperform in 2022, despite variable interest rates and robust credit conditions.