What’s going on with municipal bond funds?

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Susan Dziubinski: Hello, I’m Susan Dziubinski from Morningstar. Municipal bond funds have been in fairly steady demand this year. I join me today in discussing why Elizabeth Foos. She is a Senior Analyst in Morningstar’s Manager Research Group.

Beth, thanks for being here today.

Elizabeth Foos: Thanks for having me, Susan.

Dziubinski: Let’s start by talking a little about the starters. Muni-bond funds have benefited from a fairly constant inflow. In fact, they have seen influxes over the past 16 consecutive months. Why do you think it is?

Foos: I think there are a few key factors that have really fueled this historic demand for munis in 2021. First, the overall credit quality in the municipal market is generally quite good. Muni’s issuers have been supported by a significantly improved economic environment in the United States this year, as well as very generous stimulus packages from the federal government that were really able to close these budget gaps when they arose. And more recently, investors in the United States are really recognizing the potential for tax increases in the months, if not years, to come. And the tax-free income offered by muni bonds is really attractive.

Dziubinski: Beth, how have muni-bond funds in general fared so far this year?

Foos: I think the rally in munis has really been a bright spot in the fixed income markets in 2021. And overall, the municipal bond funds that hold this riskier debt – hence, the bonds that are more risky. sensitive to changes in interest rates or have lower credit quality – have really outperformed their taxable counterparts. This trend has diminished a bit over the past few weeks and months, but since the start of the year, it’s still true.

Dziubinski: And as you alluded to Beth, we’ve seen that municipal high yield bond funds have done very well this year. What motivated this performance?

Foos: Well, again, I think even with some of the more struggling issuers, credit quality has always been relatively strong. Although the valuations have been stretched, the portfolio managers are still signaling that there are deals to be done there, and the potential for return in this particular space has simply been more attractive than that of other fixed income bonds. .

Dziubinski: Beth, we’ve seen Nuveen High Yield Municipal Bond, the biggest strategy in the high yield mun categories, closed to some new investors, and you don’t often see a bond fund close. So tell us a bit about what happened there. And does that say anything bigger about the high yield municipal market in general?

Foos: It’s true, we don’t see that very often. But this fund is by far the largest in our Morningstar High Yield category, and has seen significant inflows, especially over the past three years. Thus, the company announced that it would close new investors, mainly to moderate the growth of its assets. And I think what that means, especially about the high-efficiency munitions market, is that although it is very popular, the true high-efficiency munitions space is a very small part of the overall municipal market. And it’s small, it’s opaque, and a lot of that debt comes into the market without rating. So it really does require a bond-by-bond review in order to understand all the risks and potential that these holdings may present to an investor.

Dziubinski: Let’s say there is an investor who thinks I might want to try a high yield bond bond fund, what are some of the risks you should be aware of?

Foos: Good question. While defaults are historically quite rare in the municipal bond market, most of them occur in the municipal high yield space. Funds that buy these high yield municipal bonds offer higher returns, but, of course, there is more risk associated with that, and there is generally more volatility over a market cycle for investors. Thus, people interested in managing their tax burden and having a slightly higher tolerance for risk could be well served with a municipal fund.

Dziubinski: And we give a number of high yield bond funds a very high rating. One example is T. Rowe’s Price Tax-Free Yield, which gets our best rating, our best fund analyst rating for gold. Tell us a little bit about this bond and what we love about it.

Foos: Sure. T. Rowe Price Tax-Free High Yield is managed by a very large and experienced team of portfolio and credit analysts. They use extensive research, bottom-up research and sophisticated tools to manage the potential and risk associated with investing in this space. The portfolio won’t take on too much of unrated debt or the riskier parts of the high-yield municipal sector, but senior portfolio manager Jim Murphy works closely with his counterparts in T’s corporate bond office. Rowe to manage a company backed muni sleeve, which makes it a bit unique in the space. And over time, this combination has served investors really well by providing a consistent risk / reward profile.

Dziubinski: And then there are a few other funds that we have assigned silver analyst ratings to in this high yield bond bond category. Tell us about these.

Foos: Sure. There are three other strategies that get silver ratings on their cheapest share class. There are American High-Income Muni, BlackRock High Yield Muni and MFS High Income Municipal Bond. While each portfolio may focus on different sectors of the municipal bond space at different times, overall, again, all of these funds are managed by highly experienced, seasoned teams who do very bottom-up research. solid. So at the end of the day, they really understand the risks of every particular position they put in their municipal bond fund.

Dziubinski: Well, Beth, thank you very much for your time today, not only for keeping us up to date with what’s going on in the municipal bond landscape, but more specifically for your attention to this municipal bond market at high efficiency. We appreciate your time.

Foos: Thank you very much, Suzanne.

Dziubinski: I’m Susan Dziubinski from Morningstar. Thank you for signing in.


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