As mentioned in the most recent Muni Market Monitor, high yield muni funds have accumulated $24 million of net inflows year to date, representing ~20% of total inflows to the total municipal category. With the prospects of higher individual tax rates and the continued need for after-tax income, tax-aware investors have found shelter in the higher yielding non-investment grade municipal market in record volumes. For those investors that recently allocated to the high-yield space or those that are considering it, below are some things to know about the asset class.
“Income investors have been challenged to find attractive yields within the more traditional fixed income markets and that has caused some investors to look to other, maybe unfamiliar, markets,” noted LPL Financial Fixed Income Strategist Lawrence Gillum. “Investors should certainly consider the risks associated with higher yields, and the high yield muni market is no exception.”
- The index is concentrated in only a few sectors: The lower rated municipal index is dominated by revenue bonds, which are bonds that are used to fund specific projects. Revenue generated from these projects is then used to pay back the interest on the loans. Revenue bonds tend to be riskier than general obligation bonds because they lack the taxing authority to support interest payments.
- Liquidity risk is an important consideration: The high-yield muni market can, at times, be fairly illiquid. As seen on the LPL Research Chart of the Day, the total market value of issuers within the high yield index is only around $150 billion, which is dwarfed by the national muni market at over $1.6 trillion and the corporate high-yield market at over $1.7 trillion. Moreover, there are over 5000 individual bonds within the muni high yield index, which makes the debt outstanding for each individual issue very light.
- Tax-Equivalent Yields (TEY) for municipal debt still attractive: With the search for income a global phenomenon and interest rates around the world at or near multi-year lows, yields on many fixed income asset classes have been pushed lower. However, whether you’re looking at TEY or after-tax yields, for those investors in the top tax brackets, yields for the muni high yield market are still above those found in the corporate high yield market.
For a more in-depth view of the high-yield muni market, as well as how the technical backdrop for muni securities could help keep muni prices well bid, please see this month’s Muni Market Monitor.
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All index and market data from FactSet and MarketWatch.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply.
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