Municipal bond funds could have their moment in the sun after a bumpy start to the year for fixed income. According to Strategas Research, the iShares National Muni Bond ETF (MUB) saw the second-highest inflows among U.S. ETFs in the second quarter at $5.4 billion. That was behind only the SPDR Bloomberg 1-3 Month T-Bill ETF (BIL), which tracks short-term Treasuries. That continued into the early days of the third quarter, with the iShares fund registering an additional $106.7 million in inflows last week, according to FactSet. Inflows aren’t a perfect measure of investor demand, but the overall trend seems to be toward more conservative areas like municipal bonds, according to Strategas strategist Todd Sohn. “Sector flows have become decidedly defensively skewed, with healthcare and staples generating the largest inflows (combined about +15Bn the category rallied a massive +$32Bn in the first hour. Higher short-term interest rates are an additional boost,” Sohn wrote. The renewed Interest in the fund came after a bumpy start to the year as bond prices are moving inversely with yields, which rose sharply in the first half as the Federal Reserve began reversing its pandemic-era policies The iShares National Muni Bond ETF is down more than 8% year-to-date The Vanguard Tax-Exempt Bond Index Fund (VTEB), which has attracted more than $1 billion in inflows over the past month, is also down 8.6% year-to-date “At times during the first half of the year there was a sense of forced selling taking place in certain parts of the credit markets and I would say that Kommunalanl eihen … was one of the sectors that just looked like a pretty unrelenting amount of selling,” said Mark Heppenstall, chief investment officer at Penn Mutual Asset Management. A more optimistic second half? There are some reasons to believe that the second half of the year could be better for local authorities. For one, the 10-year Treasury yield is now well below its yearly highs, even after some big intraday jumps late last week. “Rising interest rates should also be less of a drag on performance as we believe most of the rise in yields this year is likely behind us,” said Cooper Howard, a fixed income strategist at Charles Schwab, in a statement. Municipal bonds aren’t likely to post the big gains found in assets like growth stocks, but their tax advantages over private debt can help boost payouts for income-hungry investors. Interest paid by governments on municipal bonds is not subject to federal income tax. The iShares fund’s payout has been about 1.9% over the trailing 12 months, but larger payouts have been made during periods of higher interest rates. As new bond issues are added to the fund’s portfolio, the payout could increase. With yields soaring this year and worries of an economic slowdown widening spreads, high-quality debt, which is slightly riskier than Treasuries, could be a sweet spot for investors. “The municipal side and the high-quality corporate side would both be more attractive than treasuries at the moment,” said Heppenstall. According to Howard von Schwab, this is particularly true for longer-term bonds. “Long-term Munis are more attractive than short-term Munis. Yields relative to government bonds are more attractive for longer-dated munis than for short-dated munis,” Howard said. The two main ETFs offer relatively cheap and easy ways to participate in the market. The iShares fund and the Vanguard fund, which pay out monthly, have an expense ratio of less than 0.1%. There are several other municipal bond ETFs with sizeable assets, including offerings from Nuveen and Invesco.
