Crazy Markets - Remember That Old Standby: Municipal Bonds
Advisors Asset Management
By Tom Dalpiaz
May 29, 2012
Sometimes it takes heightened uncertainty and increased market volatility to help investors rediscover an old friend in the investment universe. We thought it would be useful in today’s difficult market conditions to list a series of questions as a reminder of what municipal bonds, properly selected and managed, can do for investors. Don’t worry; the questions we pose aren’t tough. In fact, it should come as no surprise, given the title of this blog, that you can receive an “A” grade on the following quiz by answering “municipal bonds” to each of the questions listed below:
What asset class allows investors to avoid federal, state, and local income taxes? Traditional tax-exempt municipal bonds are exempt from federal income taxes and can be exempt from state and local income taxes if in-state municipal bonds are purchased.
What asset class is large, diverse, and easily customize-able? The municipal bond market has roughly $3.7 trillion in bonds outstanding, over 55,000 separate issuers of bonds, and a dozen broad sectors and security types. Municipal bonds offer a wide variety of maturity dates, coupons, call features and degrees of credit quality. This size and diversity is particularly helpful for investors when customizing their specific investment journey.
What asset class has a safety record (from issuer default) second only to U.S. Treasury securities? According to Moody’s, investment grade municipal bonds experienced a default rate of 0.08% from 1970 through the end of 2011. That’s less than 1/10 of 1% (even including the very challenging environment of the past four years).
Historically, what asset class has been unlikely to decline 200 to 300 points in a few days? We ask this question somewhat tongue-in-cheek but do so to highlight the relatively modest volatility characteristics of investment grade, intermediate maturity municipal bonds.
What asset class has a strong possibility to increase in value as the concern over Eurozone cohesiveness intensifies? At various points in time this year, municipal bond values have increased as a flight-to-quality rally in Treasury bond prices pushed both Treasury and municipal bond yields lower. This “fear trade” tends to intensify in times of heightened European uncertainty.
When does 2.75% = 4.23%? When does 2.75% = 4.55%? These formulas reveal what investors would have to find in the Treasury bond market to equal a 2.75% yield in the municipal bond market. Investors in the top 35% federal income tax bracket would have to find a 4.23%. If the top rate were to go to 39.6%, they would have to find a 4.55%. 10-year and 30-year Treasury yields are currently 1.75% and 2.84%, respectively.
What has produced an average annual gross rate of return between 4.50% and 5.25% over long periods of time? Investment grade, intermediate maturity municipal bond portfolio managers as a group have demonstrated admirable consistency. Examine the total return results of this group over different time periods (whether for seven years, 10 years, or 15 years, or longer) and you will find average annual gross rates of return between 4.50% and 5.25% and net returns of 4.20% and 4.95%.
As you might have guessed by now, we believe in the relevance and benefits of municipal bonds for many investors. Of course, the future is uncertain and no guarantees can be given. Municipal bonds are not the cure for the common cold or even the answer to every investment question, but they have exhibited admirable resiliency and provided meaningful benefits through challenging investment environments. Confusing markets? Perhaps our stack of simple, pointed questions piled high in one place can help you revisit an old friend in the investment universe: municipal bonds.
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