Looking for tax-free returns and some of the fattest yields in the bond market? Consider funds that invest in the high-yield segment of the municipal bond market.
Benefits of High-Yield Munis
Jared Woodard, BofA’s head of exchange-traded fund strategy, says high-yield munis have low default rates, with credit risk similar to that of investment-grade corporate bonds. That means investors can harvest some of the highest muni yields in recent history while keeping credit risk in check.
Attractive Yields with Lower Risk
“High-yield munis offer 8% to 9% yields on a tax-adjusted basis, near the highest levels since 2017, but with less default risk than high-yield corporate bonds,” says Woodard. “You’re getting more yield for less risk. That’s a pretty compelling place to be in fixed income.”
Flows vs Trade Calls
He notes that over the past year, high-yield muni ETFs suffered outflows while investors poured money into long-term Treasury bond ETFs. That may have been the wrong call.
“We think it’s an extremely unattractive trade to sell the high-yielding, lower-duration asset—that is, lower risk of interest rates and inflation—in order to buy funds that give you less yield and have more risk from inflation,” he says.
Considerations for Tax Day
With tax day a month away, it’s worth considering potential tax drags on your portfolio. Corporate-bond coupon payments are usually taxed as ordinary income whether they’re reinvested or not, says BofA, while most muni bond coupons are exempt from federal, and sometimes state, taxes.
Top-rated Muni Bond ETFs
BofA identifies three top-rated muni bond ETFs with the most attractive credit exposures and above-average yields:
SPDR Nuveen Bloomberg High Yield Municipal Bond ETF (HYMB)
With a tax-adjusted yield of 8.7% and an expense ratio of 0.35%, this $2.5 billion ETF returned 7.73% in 2023.
VanEck High Yield Muni (HYD)
This $2.9 billion ETF, launched in 2009 with a 0.32% expense ratio, saw returns of 6.52% in 2023. It was the first high-yield muni ETF to hit the market.
First Trust Municipal High Income (FMHI)
At $570 million in assets, this actively managed ETF has a tax-adjusted yield of 6.3% and charges a 0.70% expense ratio. It delivered total returns of 7.19% last year.
Active vs. Passive Management
While both SPDR and VanEck offer passive management, First Trust ETF stands out with an active approach. Ryan Issakainen, ETF strategist at First Trust Advisors, highlights the importance of active management in compensating investors for risk.
Traditional Muni Funds Option
For investors seeking active management in a traditional muni fund, Vanguard High-Yield Tax-Exempt (VWALX) presents a strong option. With a fee of only 0.09%, this $15.2 billion fund outperformed 92% of its peers with total returns of 8.44% in 2023.
Key Points to Consider
- Security selection and diversification play a vital role in the success of muni bond investments.
- Nathan Will, head of municipal credit research at Vanguard, stresses the importance of having an experienced team selecting credits in the diverse high-yield market.
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