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Taxes - Friday, 04/19/2013

The $3.7 trillion municipal bond market resides largely in the domain of individual investors, whether through direct purchases or financial intermediaries. Monday was tax day — a day when investors can truly realize the benefits of municipal investments.

Although returns have been subdued so far this year (0.93% for the Barclays Municipal Bond Index and 2.56% for the Barclays Municipal High Yield Bond Index1), those who invested in munis in 2012 were rewarded with strong performance (6.78% and 18.14% for the investment-grade and high-yield indexes, respectively).

I believe the increase in the top income tax rate to 39.6% has created an additional benefit for income seekers who continue to commit to municipals. For those considering new allocations, however, there are some uncertainties, especially in the context of the latest budget proposal by the administration.
 

What you should know:

  • Warnings have been issued from influential groups such as the National League of Cities about the detrimental effects of impairing the municipal market’s ability to provide states and municipalities with access to low-cost capital.
  • Capping the exemption would, in my opinion, harm more than the (very) wealthy. Studies from leading bank analysts reveal that municipal investors are a broader group of wage earners than previously thought; many fall well below the top tax bracket.
  • BofA Merrill Lynch research suggests that a 28% cap would raise only a small fraction of the exemption’s roughly $30 billion current "expenditure" while significantly raising borrowing costs for issuers.
  • I believe we are nearing the end of a "seasonal adjustment" which has seen issuance surge and demand ebb. The combination of headline concerns, income tax payments, and a large supply of new bonds may create a better buying opportunity in the coming weeks.

So while Congress debates, in my opinion, opportunity could present itself in the near term.


Munis Attractive at Ratios ≥ 100% of U.S. Treasuries2 

 Maturity 

Yield Ratios 

1 Year

172.40%

2 Year

126.09%

5 Year

105.71%

10 Year

100.00%

20 Year

113.51%

30 Year

100.69%

Ratio of U.S. Treasuries to AAA munis. Source: Bloomberg as of 4/15/13.


1Returns as of 4/15/13. The Barclays Municipal Bond Index is considered representative of the broad market for investment-grade, tax-exempt bonds with a maturity of at least one year. The Barclays Municipal High Yield Bond Index is considered representative of the broad market for below investment-grade, tax-exempt bonds with a maturity of at least one year.


2The municipal to Treasury ratio is a comparison of the current yield of municipal bonds to U.S. Treasuries indicating whether municipal bonds offer attractive yields compared to Treasury yields. If the ratio is below 100%, municipal bonds are yielding less than Treasuries; if the ratio is above 100%, municipal bonds are yielding more than Treasuries.


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Important Disclosure 

Van Eck Associates Corporation does not provide tax, legal or accounting advice. Investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service.

Please note that MUNI NATIONs that are written by Jim Colby represent his opinions and these opinions may change at any time and from time to time. MUNI NATION is not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Global. © 2014 Van Eck Securities Corporation. MUNI NATION is a trademark of Van Eck Associates Corporation.

All indices listed are unmanaged indices and do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

Any discussion of specific securities mentioned in the commentary is neither an offer to sell nor a solicitation to buy these securities.

Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer’s financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Bonds and bond funds will decrease in value as interest rates rise. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. Municipal bonds may be less liquid than taxable bonds.

The income generated from some types of municipal bonds may be subject to state and local taxes as well as to federal taxes on capital gains and may also be subject to alternative minimum tax.

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