Municipal bonds aren’t the most exciting segment of the fixed income market. However, they are increasingly gaining positive calls heading into 2025. Some market observers are even advocating that income investors consider adding some municipal bond credit risk in the new year, an objective made easier thanks to exchange traded funds such as the VanEck High Yield Muni ETF (HYD ).
This ETF follows the ICE Broad High Yield Crossover Municipal Index. It is already rewarding investors for taking on added credit risk. The ETF is beating the largest fund in the category by a better than 2-to-1 margin this year.
For market participants unfamiliar with lower-rated munis, it’s important to remember that these bonds carry less risk than their junk-rated corporate peers. Additionally, muni defaults are much more rare than comparable action among corporates. Still, HYD provides decent compensation for what amounts to be only slightly more risk. The ETF sports a 30-day SEC yield of 4.20%, or 90 basis points more than the ICE AMT-Free US National Municipal Index.
Why HYD Could Star Next Year
There are some words of caution for muni investors to consider heading into 2025. Fixed income experts expect that the first few months of the new year could be challenging for municipal debt. That’s because of debate over the Tax Cuts and Jobs Act (TCJA) of 2017.
With Republicans’ scant House majority, it’s unclear how many concessions will need to be made in terms of extending TCJA. It’s also widely believed that when that political headwind subsides, munis and ETFs such as HYD could deliver upside for investors. A selling point for funds such as HYD is that municipal bonds remain highly relevant considerations for affluent investors.
“The yield on the Bloomberg Municipal Bond Index, which is a broad index of munis, was 3.4% as of December 3, 2024. That’s the equivalent of roughly 7% for a fully taxable bond for an investor in the top federal tax bracket in a high-tax state like New York or California. Municipal bonds generally pay interest income that’s exempt from federal and potentially state income taxes (if purchased from your home state),” noted Cooper Howard of Charles Schwab.
When it comes to yield, munis look compelling on a risk-reward basis compared to other corners of the bond market.
“It’s not just absolute yields that are attractive now. When compared to other fixed income asset classes, a similar story holds: Muni yields, especially after considering taxes, are attractive relative to their risks,” concluded Howard.
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