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Advisors know that municipal bonds aren’t a glamorous asset class, but munis are an essential part of the equation for a broad swath of clients, including retirees needing income and those living in high income tax states.
On those notes, it’s encouraging to see solid performance by municipal debt this year. Through the first 11 months of 2024, the widely followed ICE AMT-Free US National Municipal Index is up 2%. That’s encouraging because with the calendar nearing 2025, issues such as interest rates, the need for income and retirement planning are likely to loom large next year.
Good news to be sure, but advisors might do well to consider funds – active or passive – including exchange traded funds, for municipal bond access because this is an expansive corner of the bond market and one where it’s burdensome to select individual issues.
“Based on research from Nasdaq, there are more than 80,000 municipal issuers, and more than 1.5 million municipal bonds have been issued. It can be difficult for individual investors to navigate this market given its size, complexity, and lack of liquidity. Trading costs can be prohibitive, as well. Bid-ask spreads reportedly range between 1% and 4%, and one financial writer found the average spread for holdings he was trying to sell was about 2.85%,” noted Morningstar.
Munis Have 2025 Tailwinds
Despite a recent spate of issuance, much of which was absorbed by ETFs, experts believe municipal bonds are set up for impressive showings in 2025.
“We expect the net supply picture to turn more favorable for investors into year-end, with net supply projections of -$6 billion in November and -$14 billion in December,” notes Goldman Sachs Asset Management (GSAM).
Another potential catalyst for municipal bonds in 2025 and one that’s particularly important to clients in high tax brackets are the attractive after-tax yields currently available with munis.
“From a yield perspective, investment-grade munis currently yield 3.6%. For investors in the top federal tax bracket, that places the taxable equivalent yield on investment-grade munis at 6.1% – nearly 1.3 percentage points higher than those of comparable taxable bonds,” adds GSAM. “We believe these compelling after-tax yields should continue to lead to strong investor demand into the asset class across mutual funds, ETFs and separately managed accounts.”
2025 Muni Considerations
In examining municipal bonds and the related funds as 2025 income ideas, advisors may want to consider focusing on two themes: breadth of adding credit risk.
Breadth is self-explanatory. As noted above, it can be cumbersome for any market participant to select single issues from the dizzying array of options in the muni space. Broad-based funds can alleviate that burden. On the credit risk front, advisors may want to consider indulging that because junk-rated munis aren’t as risky as their corporate peers and because state and local tax collection is expected to remain solid in 2025.
“In our view, municipal bond strategies that incorporate medium to lower-grade credit exposure are currently offering attractive absolute and tax-equivalent income opportunities,” concludes GSAM. “Year-to-date, high-yield municipal credit has outperformed investment-grade municipals. With strong credit fundamentals, adding exposure to medium- to lower-grade municipals remains a powerful addition to increase return potential in portfolios.”
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