Municipal Bonds (Munis) are a staple of the US Fixed Income landscape. Munis, issued by governmental and quasi-governmental entities, are well known for their strong credit quality and tax-exempt coupon payments.
For new Muni investors, navigating the various methods to invest in this unique asset class can be complex. Factors like cost, liquidity, customization, and tax efficiency vary across the available options, making it crucial to align your approach with your financial goals. Let's review the most common avenues to gain exposure to municipal bonds, examining the key features, benefits, and potential drawbacks of each.
Investment Options:
1. Exchange Traded Funds (ETFs)
Municipal bond ETFs are a convenient way to gain broad exposure to the Muni market. By investing in an ETF, you’re essentially buying into a diversified portfolio of bonds, often numbered in the hundreds or even thousands. ETFs are known for their low expense ratios and ease of trading, as they can be bought or sold throughout the day on stock exchanges.
Given the broad basket of bonds, customization is a challenge. For example, if you are looking for state-specific bonds to maximize tax benefits, you might find ETFs limiting as many hold bonds from multiple states. Additionally, prices of ETFs can fluctuate significantly during the day due to buying or selling pressure from retail investors even when the underlying asset prices remain stable. For this reason, there is an apparent tradeoff between volatility and liquidity.
2. Mutual Funds
Municipal bond mutual funds come in two forms:
· Open-end funds: issue and redeem shares as needed to meet investor demand
· Closed-end funds: have a fixed number of shares and trade on exchanges, like ETFs.
Mutual Funds are managed by professionals and may actively select bonds to enhance returns. Some funds utilize leverage to boost income yields, increasing risk in the process.
Management fees are typically higher for actively managed mutual funds and can reduce returns over time. Closed-end funds may trade at a discount or premium to their net asset value (NAV), reducing liquidity during times of market volatility. Like ETFs, investors are unable to customize the portfolio.
3. Separately Managed Accounts (SMA)
If you are looking for a more tailored approach, SMAs might be the right choice. These are portfolios designed specifically for you and managed by a professional with expertise in the asset class. With an SMA, you own the bonds directly and can see exactly what is in your portfolio.
This option offers maximum customization as the manager can select bonds that align with your specific goals such as state-specific bonds for tax advantages or specific credit and duration profiles. However, SMAs often require higher minimum investments and may come at a higher cost, depending on the size of your portfolio.
4. Brokerage Relationship
If you’d prefer to take a more hands-on approach, working with a broker to buy individual bonds could be a good fit. This option lets you customize your portfolio and can be cost effective.
That said, it is not for everyone. It requires knowledge of bond markets such as coupon structures, yield measures, yield curves, duration profiles, credit quality, state specific laws and regulatory environments and potential tax implications. Acquiring this knowledge base can be time consuming and labor intensive, so this option is best suited for those willing to dive deep into the details.
Why Work with a Professional Money Manager?
Professional money managers bring expertise to the complex world of Municipal Bonds. They can help optimize your portfolio by managing duration profiles and conducting credit analysis to enhance returns within your specific risk tolerance. Additionally, professionals often employ advanced tax strategies, such as tax-loss harvesting and state-specific portfolios, which can improve outcomes over time. However, for smaller accounts, the manager’s ability to diversify the portfolio can be limited and it is important to weigh the cost impact that negatively affects long-term returns.
Combining ETFs and Individual Bonds
For some investors, a blend of ETFs and individual bonds offers the best of both worlds. This combination provides added liquidity and diversification offered through ETFs, while owning individual bonds can offer stability, customization and income predictability when held to maturity.
For example, you might build a core portfolio of individual bonds tailored to your specific goals—such as state-specific bonds for tax benefits—while using ETFs to maintain liquidity for short-term cash needs or to make tactical allocation adjustments. This strategy combines the flexibility of ETFs with the personalization and stability of individual bonds.
Final Thoughts
The optimal approach to investing in municipal bonds depends on your specific financial goals, risk tolerance, and investment knowledge. While an ETF or broker relationship might appeal to someone desiring lower fees, a professional money manager’s expertise can add significant value through customization, tax management, and active oversight. For many investors, a balanced combination of ETFs and individual bonds may be the ideal mix of liquidity, customization and stability.
If you’d like to learn more about municipal bond investing or explore our tailored solutions, please reach out to our team.
Sources:
Corporate Finance Institute. (n.d.). Open-end vs. closed-end mutual funds. Retrieved December 17, 2024, from https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/open-end-vs-closed-end-mutual-funds/
Municipal Securities Rulemaking Board (MSRB). (n.d.). Ways to buy municipal bonds. Retrieved December 17, 2024, from https://www.msrb.org/sites/default/files/Ways-to-Buy-Municipal-Bonds.pdf
Nuveen. (n.d.). Investing in closed-end funds. Retrieved December 17, 2024, from https://www.nuveen.com/en-us/insights/closed-end-funds/investing-in-closed-end-funds
Disclosures:
This content has been prepared for informational purposes only and should not be considered as investment, tax, or legal advice. We recommend all investors to consult with a financial and/or tax advisor regarding their individual circumstances before taking investment decisions.
Investing in bonds exposes the investor to the risk of loss of principal. Lower and non-rated securities are more volatile and less liquid than investment grade bonds.
Please visit our website for a complete list of disclosures and risks: www.maustininvestments.com.