Investors are pouring into municipal bond funds at the fastest rate in five years, driven by attractive tax-free yields and a strong April rebound. Financial experts from AllianceBernstein, UBS, and MacKay Shields are optimistic about munis’ future performance, citing compelling valuations and resilient credit fundamentals, though Barclays advises caution regarding macroeconomic risks.
Despite recent market volatility, municipal bonds are experiencing a remarkable resurgence, capturing investor attention at an unprecedented pace. After a challenging March, these tax-advantaged assets roared back in April, with the ICE BofA US Municipals Securities Index recording its best April performance since 2014 and its first positive April since 2021. This renewed interest is evident in the substantial net inflows of approximately $22.3 billion into municipal mutual and exchange-traded funds during the first four months of the year, marking the fastest rate of investor accumulation since 2021, according to LSEG Lipper Global Fund Flows. A key driver for this demand remains the attractive tax benefits: munis are exempt from federal taxes and often from state taxes for in-state residents.
Investors capitalized on attractive prices in April following March's repricing. Matt Norton, Chief Investment Officer for Municipal Bonds at AllianceBernstein, continues to see compelling entry points. "The all-in yields are still over attractive from an income generation perspective," Norton stated. He highlighted that a muni portfolio offering a 4% tax-free yield could translate to a tax-equivalent yield approaching 7% for investors in higher tax brackets. Considering the inherent safety of the municipal bond market and what are perceived as attractive valuations, Norton anticipates "pretty strong performance over the next 12 to 18 months."
This positive outlook is echoed by UBS, which recently upgraded its house view on the asset class to "attractive." Sudip Mukherjee, senior fixed income strategist in the UBS chief investment office, noted, "We believe munis are poised to deliver strong performance over the next several months." Mukherjee pointed to appealing yields, expected improvements in technicals, a steep yield curve, and resilient credit quality as supporting factors.
However, Barclays advises a degree of caution. Mikhail Foux, head of Barclays' municipal research and strategy, warned that while tax-exempts should perform well in May, a resurgence of rate volatility, potentially fueled by geopolitical events like Iran-U.S. tensions, could introduce challenges. Foux suggested investors consider exercising caution and adding to positions during periods of weakness.
Finding opportunities remains key. Norton at AllianceBernstein believes ample supply this year will be met by robust demand, driven by attractive valuations and solid income streams. He also highlighted the historically steep yield curve, favoring 15- to 30-year bonds for potentially strong performance. Norton recommends credits rated A, BBB, or even higher-yielding assets with strong credit fundamentals. Within revenue bonds, he prefers affordable housing and senior housing sectors, citing high occupancy rates, low historical default rates, and resilience even in a slowing economy. Senior housing, in particular, benefits from an aging population.
UBS, meanwhile, recommends the 20-year portion of the yield curve for long-term absolute returns. They favor high-quality bonds, suggesting a 75% allocation to AAA- and AA-rated assets and 25% to A-rated. Eric Kazatsky, client portfolio manager at MacKay Shields, has shifted focus from general obligation to revenue bonds, finding better relative value in essential service credits like water, sewer, public power, and transportation. These sectors offer identifiable revenue streams and robust covenant protection. Kazatsky also eyes the 17- to 22-year area of the curve as most attractive.
Overall, Kazatsky views munis as highly appealing, especially when compared to the risk profiles of other fixed-income assets. "We are outperforming Treasurys. We are outperforming corporates," he asserted. "Given the amount of risk you’re taking in munis with those very, very low historical default rates, it's kind of impressive."
