Investors looking for tax-advantaged income can still discover attractive opportunities within the municipal bond market, though careful selection is advised, according to Patrick Haskell, head of BlackRock's municipal bond group. BlackRock reports that municipal bond issuance is projected to surpass $580 billion this year. Concurrently, new cash inflows into muni bonds reached $56.6 billion in the first half of the year, marking the second-strongest start to a year on record.
"Patience will be key for the second half," Haskell stated. "Opportunities will arise, but it's crucial to focus on the right credits, structures, and pricing. We maintain a cautiously optimistic outlook for the latter half of the year."
Municipal bonds are a favored investment for high-income individuals due to their generally lower risk profile compared to corporate bonds. They are typically backed by the taxing authority's full faith and credit. While their stated yields may be lower than those of corporate bonds, the income generated is exempt from federal taxes. Furthermore, residents of the issuing state may also benefit from state and local tax exemptions.
The value of tax-free yield is significantly higher for those in elevated tax brackets. For instance, an individual in the 32% federal tax bracket, also subject to the net investment income tax, would need a taxable bond yielding 5.45% to match the after-tax income from a 3.5% tax-free municipal bond.
BlackRock's preferred municipal bond sectors include the longer end of the yield curve, particularly issues maturing in the 20- to 22-year range, while remaining neutral on overall duration. Haskell noted that while longer-dated bonds carry higher interest rate sensitivity (duration risk), investors are compensated for taking on this risk in the muni market.
His team also prioritizes high-quality bonds with higher coupons, favoring those yielding upward of 5% as a hedge against market uncertainty. Specifically, revenue bonds are favored, especially those in the housing and transportation sectors. These bonds, issued by public agencies, are secured by the revenues generated from specific projects like housing developments or toll roads.
The S&P Municipal Bond Housing Index currently offers a yield-to-worst of 4.34%, equating to a tax-equivalent yield of 7.33% for an investor facing a 40.8% effective tax rate. The S&P Municipal Bond Transportation Index shows a yield-to-worst of 4.06%, translating to a tax-equivalent yield of 6.86%.
Haskell also recommends select corporate-backed municipal bonds, which are government-issued but backed by a corporation, often for industrial development or pollution control projects. The S&P Municipal Bond Corporate-Backed Index boasts a yield-to-worst of 4.39%, offering a tax-exempt yield of 7.42%. "In general, the municipal bond market is in a strong position," Haskell concluded.
