Taxable Munis? They’re Worth a Look
Sound describes the credit quality. But it doesn’t do justice to the stellar performance.
To herald this new decade, I decree that we quit bemoaning the Great Recession and credit crisis of 2008–09 and its many calamities. It happened, it was costly, we learned something about defaults and diversification—and it’s old news. But before we lock the door on those dark days, I offer a shout-out to one of the meltdown’s few rewarding legacies: the taxable municipal bond.
Yes, there is such a thing. A handful are general obligation bonds, issued by municipalities, but the vast majority are construction or infrastructure bonds issued and backed by a public entity. Some 15% of fresh state and local debt today pays interest subject to federal income taxes, and the yields to maturity are considerably higher than Treasuries or regular municipals—often, over 3% for 15-year bonds or 5% for 20-year debt. In 2019, taxable muni issuance spiked amid high demand, and that has carried into 2020 because of the hunt for yield and these bonds’ powerful appeal for IRAs, pension funds and foreign buyers who would gain no advantage from tax-frees anyway.
Overseas demand is often the trigger for issuers to add a smaller taxable portion to a large tax-exempt offering. After all, a 3.2%, 15-year bond rated A+ and backed by, say, an international airport’s terminal and parking revenue is an easy sell in negative-yield Europe. Taxable muni issuers have recently included the Port Authority of New York and New Jersey, the Dallas–Fort Worth airport, the Multnomah County, Ore. (Portland-area) school district, and several state college and university systems.
Sound describes the credit quality. But it doesn’t do justice to the performance of these bonds. Standard & Poor’s Taxable Municipal index has returned 12.9% over the past year, compared with 8.1% for the comparable S&P long-term tax-free index and 10.8% for the broad bond market yardstick, the Bloomberg Barclays U.S. Aggregate. Vanguard’s broadest taxable bond exchange-traded fund, BND, made 10.9%, which is sweet but not as spectacular as taxable muni returns. Lest you dismiss these munis as a one-year wonder, the 10-year annualized gain for that S&P taxable muni index is 6.5%, which beat the 5.3% from an index of bonds issued by firms in the S&P 500 index, a fair comparison of high-grade taxable issuers.
Strong fundamentals. The engines for continued impressive returns are the fundamentals, which include more-compelling yields than other taxable debt, comparable or superior credit ratings, and, as Baird municipals maven and portfolio manager Duane McAllister puts it, the security of knowing you are lending to public institutions rather than to corporations that are subject to industry cycles or laboring under high or questionable debt burdens. Recession, as always, is a risk, but where’s the recession? Not seeing it, friends.
Taxable munis also benefit from being mostly non-callable, unlike corporate bonds. Although some are slated to be refinanced on a fixed schedule, you can assume the attractively high coupon will survive 10 years or longer. Jason Audette, who manages separate municipal accounts for Appleton Partners, calls the design “a low-risk, high-income anomaly.” Though I often espouse owning individual muni bonds, there are a few of these I would reject, such as debts backed by nursing homes and minor-league baseball parks. Fund investors can consider the Invesco Taxable Municipal ETF (symbol BAB, $32), tracking the performance of a U.S. taxable muni debt index, and two closed-end funds, BlackRock Taxable Municipal Bond Trust (BBN, $24) and Nuveen Taxable Municipal Income Fund (NBB, $22). The closed-ends’ active management has given them an edge, and both are, remarkably, priced below net asset value.