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High Yield Municipal Bonds: The Only Game in TownMichael Cohick, Senior ETF Product ManagerAugust 09, 2018
The persistent clamor from investors seeking opportunity and direction this summer is set to become even louder. August is expected to bring with it an estimated (and significant) $51 billion in potential reinvestment demand from municipal bond holders. This means the supply/demand imbalance, in place for some time now, is likely in my view to continue to be favorable for municipal bond performance. We typically experience a larger disparity between supply and cash in June and July, but this year August looks set to present the larger imbalance.
This may bode well for both investment grade and high yield municipal bond performance for the remainder of the year. What’s more, the reinvestment dollars that return to separate managed accounts (SMAs), banks, and insurance company portfolios from coupons, maturities, and calls may keep volatility in check.
Moreover, we believe market technicals to be especially supportive of the high yield market. As one of the few bright spots in fixed income globally, muni high yield performance this year has been of particular note: the Bloomberg Barclays High Yield Municipal Bond Index had returned an impressive 4.03% in 2018, as of the end of July. We anticipate that investors chasing the few available bonds will be favorable for prices.
Year-to-Date Global Fixed Income Index Total Returns
Source: Bloomberg Barclays. Data as of 7/31/2018. For illustrative purposes only. See asset class index definitions below.
The high yield municipal bond market in particular has held up well so far this year, despite the refinancings that have taken a significant portion of bonds out of the high yield secondary universe. For example, tobacco issues, yielding 7% and generating attractive income for yield investors, were called in California and New Jersey. This led to pressure on the remaining high yield inventory and moved prices higher. We believe that these trends are positive indicators for the prospects of the high yield municipal bond sector.
Municipal High Yield: Bloomberg Barclays Municipal High Yield Bond Index includes below investment-grade tax-exempt bond market. U.S. Floating Rate Notes: Bloomberg Barclays US Floating Rate Notes (<5 Y) Index consists of debt instruments that pay a variable coupon rate, a majority of which are based on the 3-month LIBOR, with a fixed spread, and may include U.S. registered, dollar denominated bonds of non-U.S. corporations, governments and supranational entities. U.S. Corp High Yield: Bloomberg Barclays U.S. Corporate High-Yield Bond Index includes below investment-grade corporate debt from U.S. issuers. Municipals: Bloomberg Barclays Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt municipal bonds with a maturity of at least one year. U.S. Treasuries: Bloomberg Barclays U.S. Treasury Index includes public obligations of the U.S. Treasury. U.S. Aggregate: Bloomberg Barclays U.S. Aggregate Bond Index includes government and corporate securities, mortgage pass-through securities, and asset-backed securities. Global Aggregate: Bloomberg Barclays Global Aggregate Bond Index includes Eurodollar and Euro-Yen corporate bonds, Canadian government, agency and corporate securities, and USD investment grade 144A securities. U.S. Corporates: Bloomberg Barclays Corporate Bond Index includes taxable corporate debt from U.S. issuers. EM USD Sovereigns: Bloomberg Barclays EM USD Government Bond Index includes USD denominated government debt from emerging markets issuers. EM Local Sovereigns: Bloomberg Barclays EM Local Currency Government Bond Index includes local currency denominated government debt from emerging markets issuers.
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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.
Diversification does not assure a profit or protect against loss.
Investing involves substantial risk and high volatility, including possible loss of principal. Bonds and bond funds will decrease in value as interest rates rise. An investor should consider the investment objective, risks, charges and expenses of a fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.
Authored byMichael Cohick
Senior ETF Product Manager