As inflationary pressures ease and expectations of central bank interest rate cuts rise, investors are looking for exposure to assets that can deliver solid returns and a high degree of security.
Against this backdrop, Insight’s Jeffrey Burger believes US municipal bonds could be a good fit for both US domestic and international investors seeking an attractive combination of healthy yields and low default prospects.
“As central bank support measures such as quantitative easing become increasingly distant memories, the so-called regime change that has seen economies shift from low-to-zero interest rates to a higher-rate, more inflationary environment is providing a strong tailwind for US municipal bonds,” he says.
“The US Federal Reserve’s (Fed) unrelenting efforts to tackle inflation and resulting interest rate rises have helped buoy municipal bond yields and we expect this trend to continue. We believe we are currently in a window of generationally high yields for what are also, intrinsically, very safe investments. In our view, we are seeing some of the best opportunities in this sector in a generation.”
Market longevity
From a safety standpoint, Burger points to the sheer longevity of the US municipal bond market. The first municipal bond in the US was a general obligation bond issued by the City of New York for a canal back in 18122.
Defaults in the sector, he adds, are extremely rare, with the asset class proving historically resilient to wider market fluctuations. The ability for municipal debt issuers to honour their debts to bond holders reflects the fact that many of these public corporations are virtual monopolies that deliver services with inelastic demand to the public.
“Historically, municipal bonds have been very strong, stable securities during periods of economic challenges. These bonds generally hold up very well from a credit perspective during times of market stress, in large part because of the essential nature of the asset class. In aggregate, taxable municipal bonds also tend to have a higher credit rating relative to US investment grade corporates,” adds Burger.
There are other positive aspects to this fixed income asset class. Many municipal bonds help fund projects and infrastructure development that support the public good. They are issued across the US with California, New York, Texas and Florida among the biggest issuing states.
“Muni bonds can and do help fund the development of local hospitals, public health and education facilities, clean water, public transportation and other aspects of municipal life that support American people in their everyday lives. They are generally tied to a fundamental and positive need to develop US public infrastructure.
“In many cases these bonds have a direct link to the revenue streams of underlying infrastructure assets and/or the backing of the tax revenue streams of individual states. They can also be a great diversifier in portfolios, allowing investors to diversify without sacrificing returns,” he adds.
Untapped potential
With such positive aspects some investors may question why ‘muni’ bonds have not yet attracted a more mainstream audience outside the US, adds Burger. He believes that despite its long history, the US municipal bond market is still comparatively under researched, allowing global investors many potential pockets of value to exploit.
“While municipal bonds are long established in the US, they are a relatively new asset class to many non-US investors and, we believe, offer a significant opportunity to this market. Nor do we believe it is too late to get involved in the market. In fact, for those who have been studying this assets class or continue to study and get interested and excited about it, we believe a major window of opportunity is still open.”
Burger has seen a recent spike in issuance ahead of the upcoming US election which he says is a common feature of election years. But he also sees no shortage of demand in a market Burger believes can hold its own against US Treasury and investment grade (IG) corporate credit exposure.
“A growing US federal deficit means Treasury issuance is expected to continue to balloon which cannot be good news for the US Treasury market in the long run. With US munis, investors are buying into an asset class that can also provide significantly better credit quality, comparable yield, and less chance of defaulting than many IG corporate bonds.
“Many US municipal governments are also sitting on ‘rainy day’ money that would be used if the wider economy suffers a downturn. It is also very rare indeed for a municipal bond, particularly those that are rated investment grade to default3.”
Either way, Burger is confident the municipal bond market will continue to attract new investors and offer some compelling opportunities.
“While muni bond investment is a US market mainstay with a long history, we are seeing more and more European investors taking a keen interest in the sector. They are attracted by both the yields on offer and the type of beneficial public works and initiatives the underlying assets can fund. As such, we believe they will continue to present attractive opportunities for both domestic US and non-US investors,” he concludes.
