BlackRock’s Patrick Haskell identifies municipal bonds as a key area for finding solid tax-free yields, especially appealing to high-income investors due to their federal and sometimes state/local tax exemptions. Despite strong issuance and cash inflows, BlackRock advises a selective approach, favoring long-duration, high-quality revenue bonds in sectors like housing and transportation, as well as select corporate-backed municipal bonds. The firm is cautiously optimistic for the second half of the year, believing the compensation for duration risk in munis is worthwhile.
Investors searching for compelling tax-advantaged yields can still uncover robust opportunities within the municipal bond market, though a strategic and selective approach is paramount, according to Patrick Haskell, BlackRock's head of the municipal bond group. BlackRock's data indicates that municipal bond issuance is projected to exceed a substantial $580 billion this year. Concurrently, new cash inflows into muni bonds reached an impressive $56.6 billion in the first half of the year, marking the second-best start to any year on record for the asset class.
Haskell emphasizes the virtue of patience for the remainder of the year. "The key for the second half will be patience," he advised. "There will be opportunities, but you want to buy the right credits, the right structures and the right levels. We are cautiously optimistic in the second half."
A Go-To for High-Income Investors
Municipal bonds have long been a favored instrument among the affluent. They are generally perceived as safer than their corporate counterparts, often underpinned by the full faith and credit of the issuing taxing authority. While their nominal yields might appear lower, their income is federally tax-exempt. Furthermore, investors residing in the issuing state often benefit from exemptions from state and local income taxes, significantly enhancing their net returns.
The tax-free nature of municipal bond income is particularly valuable for individuals in higher income tax brackets. For instance, an investor in the 32% federal tax bracket, also subject to the net investment income tax, would need a taxable bond yielding 5.45% to generate the equivalent income of a 3.5% tax-free muni bond.
BlackRock's Preferred Muni Bond Sectors
Haskell's team maintains a neutral stance on duration but shows a particular liking for segments within the long-end of the muni bond curve, specifically those in the 20- to 22-year maturity range. Acknowledging that longer-dated issues are more susceptible to interest rate fluctuations (duration risk), Haskell asserts that the compensation for this risk in muni bonds is attractive. "If you want to take duration risk, you'll want to do it in muni bonds because you get compensated for that risk," he noted.
The team also prioritizes high quality and higher coupons, trimming lower-coupon exposures in favor of bonds with coupons upwards of 5%. This strategy aims to better position portfolios against market uncertainty. BlackRock is particularly keen on revenue bonds, especially within the housing and transportation sectors. These bonds are issued by public agencies but are secured by dedicated revenues generated from specific projects, such as housing developments or toll roads.
To illustrate the appeal, the S&P Municipal Bond Housing Index currently offers a yield-to-worst of 4.34%, which translates to an impressive tax-equivalent yield of 7.33% for an investor facing a 40.8% effective tax rate. Similarly, the S&P Municipal Bond Transportation Index provides a yield-to-worst of 4.06%, or a tax-equivalent yield of 6.86%. Haskell also highlights select corporate-backed municipal bonds, which are government-issued but supported by corporate entities, often funding industrial development or pollution control projects. The S&P Municipal Bond Corporate-Backed Index has a yield-to-worst of 4.39%, equating to a tax-exempt yield of 7.42%.
Concluding his outlook, Haskell affirmed, "I will tell you that munis in general are in a good situation."
