With interest rates still at historic lows, a variety of yield-oriented asset classes continue to warrant investor attention. From real estate investment trusts (REITs) and master limited partnerships (MLPs) to dividend-focused funds like the Global X Super Dividend ETF (ARCA:SDIV) have all seen their share prices swoon over the last few years.
While all of these areas are great places to pick up some extra income, recent developments within the municipal bond sector have only strengthened munis appeal. Overall, the financial picture for state and local governments is actually getting better. For investors, now could be the time to reload on some real muni bargains.
SEE: The Basics Of Municipal Bonds
Lowest In Decades
It seems that the "hundreds of billions of dollars" of municipal defaults that were predicted during the credit crisis may not happen after all. State governments in the U.S. added to their collective debt burden in 2012 at the slowest pace in at least nearly two decades. According to bond rating service Moody’s Investors, total net tax-supported state debt rose just 1.3% in 2012. That compares to 7%, 10-year average.
Aside from not adding really any new additional debt, Moody’s reported that 62% of those municipal offerings last year were designed to pay-off and refinanced higher-cost bonds. With interest rates at historical lows, many states found its worth their while to switch out costlier bonds for cheaper ones. All while, average revenues have grown by nearly 4.1%.
While it’s taken some time, Moody’s believes that states have generally moved towards a more conservative approach to debt since the 18-month recession ended in June 2009. Perhaps more importantly, a variety of states and local governments have actually begun to see budget surpluses as non-essential spending hasn’t returned and taxes remain steady or higher. For example, Florida- who was hit hard from the housing bust- has renewed many of its borrowing programs to build new schools or highways.
These lower borrowing costs and less overall debt amounts will ultimately benefit investors in the municipal bond sector. This is strengthened even more by the fact, taxes providing ballast to these bonds and budget surpluses have been rising. Munis are exempt from federal taxes as well as state tax in the state of issuance. Generally investors in the top three tax brackets will do better in municipal bonds rather than buying a similar treasury issue and paying the tax.
SEE: Avoid Tricky Tax Issues On Municipal Bonds
Snagging Some Bargains
Given that munis tax-free nature still gives them an edge over other bonds and the recent good budget/debt news only makes them more attractive, investors may want to give them a go. No one fund does that better than the iShares S&P National AMT-Free Muni Bond (ARCA:MUB). The fund spreads it’s more than $3.5 billion in assets around 2072 different municipal bonds and currently yields a tax-free 2.69%. For investors looking for a more active touch, the PIMCO Intermediate Muni Bond Strategy (ARCA:MUNI) could be used. The fund is currently focusing on "quality" versus yield and could be a good bet if states continue to get serious about their debts.
With the Fed being to at least talk about ending its quantitative easing programs, long dated munis could get crushed if rates rise to high. That means play the short end of the spectrum could be a prudent move. The SPDR Barclays Capital Short Term Muni (ARCA:SHM) is the largest and most active fund in this area. The funds short term holdings will help cushion against rising interest rates. Likewise, iShares recently unveiled custom maturity muni bond ETF's ranging from iShares 2014 S&P AMT-Free Municipal Series (ARCA:MUAC) to iShares 2018 S&P AMT-Free Municipal Series (ARCA:MUAG). These allow investors to pick-n-choose exactly the duration they want from their muni investment.
Finally, after trading at premiums for most of 2013 and 2013, many municipal bond closed-end funds (CEF) are now once again trading at discounts to their net-asset values (NAV). The Market Vectors CEF Municipal Income (ARCA:XMPT) tracks a basket of municipal CEFs, offering investors a chance to own a wide swath of bonds with different management styles. At the same time, funds like the BlackRock Municipal Bond Trust (NYSE:BBK), Dreyfus Strategic Municipals (NYSE:LEO) and Eaton Vance Municipal Bond Fund (AMEX:EIM) all offer 6% plus dividend yields- due their leverage- and can snagged for around a 5% discount to their NAVs.
SEE: 5 Common Misconceptions About ETFs
The Bottom Line
For investors looking for tax-free income, the municipal bond sector continues to get stronger. It seems that states have finally begun to get serious about their budgets. Overall, recent trends in debt amounts and spending point to a bullish trend for the asset class. The previous picks, along with the Market Vectors Intermediate Muni ETF (NYSE:ITM), make ideal selections to play the sector.
At the time of writing, Aaron Levitt did not own shares in any of the companies or funds mentioned in this article.