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Caution: Muni Bonds Are Better Than They Appear
With yields of around 2.5%, municipal bonds may not feel all that exciting. But take a closer look. If you compare that yield with that of a taxable bond, the yield jumps to around 5%. The tax savings is that big.
Taxable Equivalent Yield
To understand why, it's important to understand the "taxable equivalent yield," which factors in the tax benefits that come from owning municipals. The interest paid by munis is usually tax exempt at the federal level; but for investors living in states where the bonds were issued, they can enjoy exemption from state and local taxes too.
Understanding taxable equivalent yields has become even more important since the tax-reform package took effect this year.
With the loss of various deductions, including state and local taxes which are capped at $10,000, one's taxable income is higher than it's ever been. For investors in certain
states with higher local taxes
such as New York, New Jersey, and California, owning municipals is more sensible than ever before.
The table to the right demonstrates the taxable-equivalent yields that a married couple living in various states could expect. For example, consider a California couple whose taxable income is $250,000 and they own a municipal bond with a stated yield of 3%. If their total tax rate is 48.1% (which is, 35% for federal taxes, 3.8% for Medicare, and 9.3% for state taxes), their taxable-equivalent yield is nearly 5.8%. That's almost twice as high as the stated yield.
Performance and Active Management
As interest rates have risen, muni bonds have not exactly been star performers so far this year. Through May 24, the Bloomberg Barclays Municipal Index has a total return of -0.9% (though that does compare favorably with the -2.2% return of the Aggregate index of all high-quality bonds for the same year-to-date period.) Also,
one needs to move down the credit spectrum to single A rated bonds with a 10 year maturity to even
get the 3% starting yield referenced in the taxable-equivalent yields table above.
So how can investors maximize their municipal bond investment?
Most investors are well aware of the benefits of passive index investing as a way to reduce expenses and realize greater overall returns. While that's certainly the case when it comes to US stocks, municipal bonds are an exception to that general rule. With approximately 1 million individual issues outstanding, the municipal market is extremely complex. Muni bond returns differ based on credit quality, maturity, sector and issuer.
An experienced, active manager looks to beat a buy-and-hold strategy by exploiting inefficiencies in the market and applying in-depth research. Active managers can:
- Take advantage of changes in the yield curve and, over time, reap returns from "rolling down the yield curve"
- Exploit price changes by using research to buy bonds that they believe will provide greater returns relative to their risk
- Take advantage of selectively investing in lower-rated bonds that offer higher yields
- Leverage the trading advantages (i.e. lower pricing) of large institutions
According to a recent peer group analysis from Alliance Bernstein, since 2009, active muni managers have out-performed passive laddered portfolios 100% of the time*. And utilizing a manager that will customize a municipal bond account based on your individual tax situation could add even more value.
To learn more about how quality active management can yield higher taxable equivalent yields, or if you'd like a free analysis of your current muni bond portfolio, give us a call.
*Past performance is no guarantee of future results. Returns in the study are represented by two-year rolling returns and "Intermediate Municipal Peers" is defined by all managers within the US SA Muni Intermediate Category. Laddered municipal strategies are represented by the average return of laddered municipal SMA strategies, which are categorized in the Morningstar US SA Muni Intermediate and US SA Muni Long categories. January 2009 is utilized as the start date because the first municipal ladder strategy appears within Morningstar in January 2009.
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After the Memorial Day weekend, stocks plunged on fears that political developments in Italy would decrease the stability in the Eurozone. Demand for safe-haven securities amid Italy's political turmoil triggered a rally in Treasuries, driving the 10-year yield to its largest one-day decrease since the Brexit vote. (Yields increased later in the week to finish only modestly below where they started.) Equities recovered later in the week thanks to more positive economic reports here at home (see Economic News below).
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> Labor Report:
Employment growth is strong and not entirely without wage pressure. In last Friday's Employment Situation report, the unemployment rate moved down to 3.8%. The monthly gain for average hourly earnings came in at the high end of expectations, to a year-over-year rate of 2.7%. The results clearly support expectations for a rate hike at this month's FOMC meeting.
> Manufacturing:
The ISM survey queries purchasing managers about the general direction of production, new orders, order backlogs, their own inventories, customer inventories, employment, supplier deliveries, exports, imports, and prices. May's headline number of 58.7 is very strong and beat expectations. Small-sample surveys like the ISM have been reporting strong conditions for more than a year but recent reports are clearly pointing to new acceleration.
> GDP:
The second GDP estimate from the US Bureau of Economic Analysis showed Real GDP growth at an annual rate of 2.2% in the first quarter. That was in line with expectations. More intriguing however, are the preliminary forecasts for second quarter GDP. The Atlanta Federal Reserve's "GDP Now" report is forecasting second quarter growth at 4.8%! Few private analysts are that high, but several respected firms are at or near 4%. Stronger consumer spending and improved business fixed investment - fueled by massive fiscal stimulus - are the primary reasons for the increases.
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The billionaire cofounder of Microsoft and chair of the Bill and Melinda Gates Foundation reportedly
reads around 50 books a year, and he chronicles his literary adventures on his blog,
Gates Notes.
Here are his top five recommendations for this summer, along with his notes on each:
Leonardo da Vinci, by Walter Isaacson. I think Leonardo was one of the most fascinating people ever. Although today he's best known as a painter, Leonardo had an absurdly wide range of interests, from human anatomy to the theater. Isaacson does the best job I've seen of pulling together the different strands of Leonardo's life and explaining what made him so exceptional. A worthy follow-up to Isaacson's great biographies of Albert Einstein and Steve Jobs.
Lincoln in the Bardo, by George Saunders. I thought I knew everything I needed to know about Abraham Lincoln, but this novel made me rethink parts of his life. It blends historical facts from the Civil War with fantastical elements-it's basically a long conversation among 166 ghosts, including Lincoln's deceased son. I got new insight into the way Lincoln must have been crushed by the weight of both grief and responsibility. This is one of those fascinating, ambiguous books you'll want to discuss with a friend when you're done.
Origin Story: A Big History of Everything, by David Christian. David created my favorite course of all time,
Big History. It tells the story of the universe from the big bang to today's complex societies, weaving together insights and evidence from various disciplines into a single narrative. If you haven't taken Big History yet, Origin Story is a great introduction. If you have, it's a great refresher. Either way, the book will leave you with a greater appreciation of humanity's place in the universe.
Factfulness, by Hans Rosling, with Ola Rosling and Anna Rosling Ronnlund. I've been recommending this book since the day it came out. Hans, the brilliant global-health lecturer who died last year, gives you a breakthrough way of understanding basic truths about the world - how life is getting better, and where the world still needs to improve. And he weaves in unforgettable anecdotes from his life. It's a fitting final word from a brilliant man, and one of the best books I've ever read.
And just yesterday, Bill Gates announced he would gift a downloadable version of Factfulness to every college graduate, saying, "The world would be a better place if literally millions of people read the book." Interested students can visit his blog, fill out their name, list their affiliated and accredited college or university and download the e-book.
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New Market Wealth Management offers modern investment solutions backed by extensive research and experience serving the needs of wealthy families. Through our strategic partnership with
Cliffwater LLC
, we have access to institutional-quality research, investment due diligence and asset allocation tools. We believe this level of experience and unique access to in-depth, sophisticated research are essential for success in today's complex world markets.
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