’Tis the Season … for (what else?) lists. There are shopping lists, wish lists, nice lists and, for those of you shopping for investment ideas, BlackRock’s recently released list of five things to know and five things to do in 2014. (My colleagues, Russ Koesterich and Jeff Rosenberg blogged about it earlier this week.) Among those five “to do’s” is to consider adding municipal bonds to your portfolio.
Given the challenging performance this year, some may be surprised to see municipal bonds among our investment preferences for 2014. But as we note in our December market commentary, there’s a great deal to like about the asset class.
In keeping with the format of our recent publication, following is a short list of things I think investors should know about munis heading into 2014:
- Detroit and Puerto Rico make for rousing headlines, but they simply do not characterize the broader municipal market. To be sure, trouble spots exist, but we see many more areas of opportunity. Note the blues and greens in the map below, which are more prevalent than the orange areas. This improving trend paints a different picture than it did only a few years ago when we introduced this map.
2. Municipal market fundamentals remain sound (stronger, in fact, than they have been in five years, as I outline in this blog post). Many states are in better shape today than they were prior to the 2008 financial crisis and economic recession. They’ve learned some hard lessons after years of austerity and tough budget-balancing decisions. We would argue that recent developments in Detroit and Illinois are market positives in that they are setting precedents that may ultimately improve the health of state and local governments as they battle high pension costs.
3. The mid-year correction in munis was dramatic. But it also was overdone and may have largely factored in the effects of Fed tapering. That means there is value to be had in munis today. We believe current market levels offer an attractive entry point into a high-quality, income-oriented asset class, and/or an opportunity to reposition your portfolio for the future.
4. For tax-conscious investors (and who isn’t these days?), munis are second to none. Given current muni-to-Treasury ratios, we calculate that high-quality 15-year municipal bonds offer tax-equivalent yields in the area of 7%. And as investors feel the pain of higher taxes on their 2013 returns, we expect the tax-advantaged asset class will earn a few more fans, a boon for performance.
5. Munis remain a high-quality source of income, particularly relative to the corporate bond market. Moody’s noted in July that of the more than 7,500 municipal entities it rates, only 34 are assigned a below-investment-grade rating.
So what does all of this mean? This time last year I was talking about paring risk and playing defense in the muni market in 2013. While volatility is likely to linger in 2014 as investors anxiously anticipate a Fed taper, a rate back-up of the kind we saw in 2013 is highly unlikely. In fact, any such reaction would be viewed as a longer-term opportunity to lock in attractive income in the asset class.
As you embark on a season of list-making and resolutions, we encourage you to look beyond the headlines and consider the advantages of municipal bonds, particularly relative to the taxable alternatives. For additional ideas on preparing your portfolio for the New Year and beyond, be sure to consult our full 2014 Outlook and The List. Happy Holidays to all.