Uncover new sources of income with taxable municipal bonds
Issuance of taxable municipal bonds, a segment of the overall municipal market, has increased in recent years, providing global institutional investors with an additional means of generating yield. Municipal bonds are debt instruments issued to support a public purpose and finance infrastructure that improves communities, such as utilities, roads, bridges, schools and hospitals in the United States.
High-quality taxable municipal bonds have had favorable yield and valuation profiles in comparison to corporate debt.
Taxable municipal bonds can strengthen an overall portfolio through yield and diversification.
Active managers with specialized credit research capabilities can capitalize on market inefficiencies.
History reveals reasons for growth of taxable municipal market
Municipal bonds, both tax-exempt and taxable, are issued by U.S. state and local governments, quasi-government entities and eligible non-profit organizations to finance capital improvements, meet cash needs or refinance existing debt. Municipal bonds support a public purpose, often infrastructure development, and the source of repayment is typically taxes and/or fees generated by a project. In the United States, ownership of infrastructure is decentralized. In fact, 97% of non-defense assets are owned by state and local governments and private entities, according to the Cato Institute.1 Municipalities and other entities rely on the funding from municipal bonds to develop and manage the country’s infrastructure projects.
Many investors seek municipal debt for its U.S. income tax-exempt status, and interest has grown globally in the taxable segment. Generally, nominal yields for tax-exempt debt are lower compared to like-quality taxable debt, as the demand from investors that need tax-exempt income drives the yields lower. Investors not subject to U.S. taxes see opportunity in the taxable portion of the market.
Historically, taxable municipal issuance has averaged close to 10% of overall municipal supply, but there have been peaks and valleys over time.
Investors not subject to U.S. taxes see opportunity in the taxable segment of the municipal market.
As long as advance refunding deals offer present value savings, issuers will continue issuing in the taxable market. Longer term, issuers have reason to switch into taxable bonds to diversify their investor base. Many issuers, especially larger issuers that are well-researched across the globe, have expressed interest in reaching new investors by issuing taxable municipal bonds.
Taxable municipal bonds are primarily high quality and support essential services
The taxable municipal portion of the market is predominantly investment grade, with more than 70% of the Bloomberg Barclays U.S. Taxable Municipal Bond Index rated AA- or better. The largest sectors are state GOs, special tax, transportation, education, local GOs and utilities. The index is split almost equally between tax-supported bonds and project revenue bonds.
1 Cato Institute, Who owns U.S. Infrastructure?, Tax and Budget Bulletin No. 78, June 1, 2017; U.S. Bureau of Economic Analysis.
Infrastructure fixed assets: Cato Institute; U.S. Bureau of Economic Analysis. Municipal issuance: Securities Industry and Financial Markets Association (SIFMA.org); Seibert Research. New money project financing: The Bond Buyer. Bond ratings: Standard & Poor’s, Moody’s, Fitch. Taxable municipal and corporate bond sectors: Bloomberg. Municipal bond yields: Bloomberg and Municipal Market Data. Corporate bond yields: Bloomberg. Treasury yields: Bloomberg (subscription required). Defaults: Municipals Weekly, Bank of America/Merrill Lynch Research; Moody’s Investor Service. Standard & Poor’s and Investortools: http://www.invtools.com/.
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A word on risk
Investing involves risk; principal loss is possible. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk. The value of the portfolio will fluctuate based on the value of the underlying securities. Bond insurance guarantees only the payment of principal and interest on the bond when due, and not the value of the bonds themselves, which will fluctuate with the bond market and the financial success of the issuer and the insurer. No representation is made as to an insurer’s ability to meet their commitments. This information should not replace an investor’s consultation with a financial professional regarding their tax situation. Nuveen is not a tax advisor. Investors should contact a tax professional regarding the appropriateness of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
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