Municipal bond yields have sunk to near historic lows. Sector and quality spreads continue to narrow. To date, municipal bond performance is on pace with that of last year's. In my opinion, this has been driven by returning confidence in municipal credit quality and demand continuing to overwhelm supply.
So where can an investor harvest returns while the Fed keeps rates low?
Near term, I see long bonds as an opportunity where few investors have dared venture. Municipal bond mutual funds once grew on the back of long-term funds, which sought to capture the maximum yields available from issuers raising capital in the markets. Deals were crafted to include "term bonds" in great quantities with maturities of 30-40 years.
With greater volatility creeping into the muni space and a flattening of the yield curve, which dramatically narrowed the yield advantage of long bonds, a shift of demand and then issuance may have removed focus from the 30-year segment. As noted recently by Bloomberg, financings generally now offer maturities of 20 years and less, catering to a demand shift to lower duration bonds.
I believe this shift has kept the curve steep between 15-30 years, and created a near-term opportunity. As evidenced by the 9.27% year-to-date total return of the Barclays Long Municipal Bond Index,* only high-yield municipals delivered greater performance so far this year.
Yes, a modest amount of long-term bonds is brought to market, but until a supply/demand shift reverses the current pattern, I believe it behooves investors seeking yield and return to consider longer-term municipal bonds.
*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 Long Municipal Bond Index is a sub-set of this broader index.
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