In The Spotlight
In The Spotlight
Choosing the right asset classes for your portfolio can be difficult. Learn more about why portfolio construction matters below.
In The Spotlight
Stay on top of the latest market developments, key themes, and investment ideas affecting your portfolio and practices.
Explore how we can help youTalk to Us
Municipal bonds, in our view, are a bit like the vegetables in your overall diet: they’re not always exciting, but they can be good for your (portfolio’s) health. Over the long-term, municipals have been effective in offering diversification in fixed income portfolios and a potential buffer against equity market volatility.
Of course, the sector has been challenged this year. In March, overall market liquidity dried up amid uncertain news about the pandemic and its potential economic fallout. And government shutdowns to limit the spread of COVID-19 have had broad economic implications for municipalities, which rely on tax revenues to support their budgets.
Even so, we think the value of tax-exempt municipals is now more important than ever. Municipals have historically offered a resilient return stream for investors who stay the course. For example, investment grade municipals have delivered positive total returns in more than 98% of rolling two year periods.1
But with AAA-rated municipal bond yields at record lows, investors need to stay nimble to meet their goals. When evaluating potential municipal managers, we think there are a few things investors should keep in mind.
Consider adding municipal credit: To improve portfolio income, medium- to lower-rated municipals can be an attractive compliment to higher quality AAA and AA-rated munis. While the pandemic has affected municipal issuers, over the long-term municipalities have employed conservative budgeting practices. With relatively low yields on US Treasuries and higher-grade municipals, allocating a portion of your portfolio to municipal credit—BBB and select high-yield issuers—may add a buffer if interest rates were to rise. But the muni market is complex, so we believe investors should be selective about their exposure to lower-rated munis to maximize the risk-reward tradeoff.
Take advantage of the broad yield curve. Predicting where interest rates are headed can be as difficult as predicting the weather, even for professional investment managers. That’s why we think it’s important that investors stay flexible when it comes to duration and maturity structure. Active municipal managers have the ability to consider adjustments to their maturity structure and their yield-curve positioning to improve return potential. For example, the current yield differential between two- and 10-year AAA-rated munis is 70 basis points.2 Earlier this year, it was less than 40. A steeper yield curve, usually a positive signal for the economy, allows municipal investors to take advantage of roll—the tendency of a bond’s value to rise as it gets closer to maturity—and the income earned on bonds, which can improve expected returns. As the following exhibit illustrates, the best performing sections of the muni yield curve or credit spectrum change from year to year.
Source: GSAM, Bloomberg Barclays. As of 8/31/2020. “Short Munis” proxied by the Bloomberg Barclays Municipal Bond 1-3 Yr Blend Index. “Interm. Munis” proxied by the Bloomberg Barclays Municipal Bond 1-10 Yr Blend Index. “Long Munis” proxied by the Bloomberg Barclays Municipal Long 22+ Yr Index. “High Grade/Mid Grade Munis” proxied by the respective components of the Bloomberg Barclays Municipal Bond Index. “High Yield Munis” proxied by the Bloomberg Barclays High Yield Municipal Bond Index. Past performance does not guarantee future results, which may vary. It is not possible to invest directly in an unmanaged index.
Think on an after-tax basis. The municipal market is changing and a recent surge of taxable municipal bonds—partly the result of recent changes to tax policy—has brought new supply to market and sparked new demand for municipals from less traditional muni investors. As active investors, we believe modest allocations to these types of issues may make sense and even offer extra income. Over time, the after-tax relationships fluctuate and it’s important to keep an eye on the relationship between high-quality municipals (taxable and tax-exempt) to unlock the most attractive after-tax result.
We suggest that investors pay attention to what the market is offering. Dynamically-managed strategies may be able to lean into market weakness and improve overall portfolio income, making them an important driver of returns in today’s low-yield world.