There could be a silver lining in the volatile clouds hovering above the bond markets. Investors may want to give municipal bonds a closer look given their sound fundamentals.
As it turned out, munis were not immune to the latest market volatility from the tariff tantrum. In addition, excess supply only exacerbated the volatility, leading to outflows from muni bond funds, according to a Morningstar report.
“We started to see volatility in the broader fixed-income markets, particularly in the long end of the market,” said Paul Malloy, head of U.S. municipals at Vanguard. “The extra volatility caused outflows in the municipal ETFs. And that put additional pressure on the high-grade part of the municipal market.”
$381 million exited muni bond funds in March after adding $6 billion in February. As Malloy noted, when investors sense a market downturn is forthcoming, they tend to head for the exits.
“A typical municipal investor is there for the stability and the income. Once you get a little bit of volatility, they make moves,” confirmed Malloy.
Nonetheless, with volatility comes opportunity. In terms of credit risk, municipal bond market typically sits somewhere between safe haven Treasuries and corporate bonds, offering fixed income investors a median option to balance credit risk and attain yield. Currently, fundamentals are sound for munis, especially when it comes to investment-grade issues. Much credit goes to local governments who have been exercising fiscal discipline.
“Local governments are in some of the best fiscal shape in decades,” Malloy added. He noted that muni bonds act independently of Treasuries, which may be affected by increased federal government spending. “There’s been responsible use of a lot of fiscal aid. We’re seeing state and local governments with rainy day funds.”
2 Tailored Options for Muni Exposure
To mitigate rate risk and thus, additional volatility, consider short-term muni bond exposure using the Vanguard Short-Term Tax-Exempt Bond ETF (VTES ). The fund tracks the S&P 0-7 Year National AMT-Free Municipal Bond Index, balancing tax efficiency with tax-exempt yield. For an appropriate level of duration risk, this balance can translate to potentially higher yields than those afforded by competing strategies.
For investors seeking a broader, catch-all option in the muni market, consider the Vanguard Tax-Exempt Bond ETF (VTEB ). The fund tracks the Standard & Poor’s National AMT-Free Municipal Bond Index. This index encompasses the investment-grade segment of the U.S. municipal bond market, giving investors only the highest quality issues. VTEB is heavily diversified, and includes debt issues from state or local governments or agencies whose interests are exempt from U.S. federal income taxes, and the federal alternative minimum tax.
Both funds feature low expense ratios, with VTES at 0.06% and VTEB at 0.03%.
For more news, information, and analysis, visit the Fixed Income Channel.
