Municipal Bonds: Exempt From Taxes, Not Risks

Against a backdrop of broader market uncertainty, municipal-bond funds have once again demonstrated their resilience. The Morningstar US Municipal Bond Index’s 5.5% one-year return through July 2026 beat most major Morningstar fixed-income indexes, and investors have taken notice. They’ve poured into the asset class at a near-record pace over the one-year period through June 2026, with approximately $105 billion of inflows into exchange-traded funds and mutual funds, lifting muni-bond prices and fund returns higher. And muni investors who took more credit and interest rate risk fared even better.

The temptation to chase the performance of that riskier muni cohort is understandable. After all, muni-bond funds’ resiliency is rooted in several advantages—tax-exempt income, high credit quality, and historically low default rates—which make these funds a fixture in long-term portfolios. But investors looking to enter the market at this time should be vigilant, as the same forces that drove the past year’s gains can quickly reverse.

Here are two funds that have thrived in the current environment by taking outsize risks relative to their muni Morningstar Category peers. Their impressive results reflect strong tailwinds, though, not necessarily enduring long-term investment edges.

Nuveen High Yield Municipal Bond NHMRX, which carries an Average People and Below Average Process rating, takes more risk than almost all its high-yield muni peers. The portfolio typically maintains one of the category’s largest allocations to nonrated bonds, which are often smaller, lower-quality, and less liquid issues. In June 2026, its 72% stake in these bonds more than doubled the peer median allocation.

The portfolio’s duration, a measure of interest rate sensitivity, remained a category outlier at 11.9 years, which was 1.7 times the 7.1-year median. The managers add further risk by employing tender-option bonds to achieve 20%-30% effective leverage. This positioning fueled the fund’s 9.4% gain, which beat roughly 95% of its rivals over the trailing one-year period through July 2026.

But investors have been hit hard here when muni markets sell off. Even with its recent success, the fund’s three-year trailing return ranked behind nearly 80% of its rivals, while its volatility (as measured by standard deviation) was one of the category’s highest.

Goldman Sachs Dynamic Municipal Income GSMTX earns an Above Average People rating, thanks to an experienced and stable management team, while its Process rating is Average because the strategy hasn’t proved itself beyond taking more credit risk than peers.

In line with the fund’s dynamic moniker, the managers have the flexibility to dial up the fund’s exposure to below-investment-grade debt, including nonrated bonds, to 30% of assets if their outlook on muni credit is bullish. While the June 2026 portfolio’s 20% allocation to these lower-quality credits was below the portfolio’s roughly 25% five-year average, it remained well above the typical muni-national intermediate peer’s 5% exposure. It’s no surprise the fund has enjoyed a nice ride recently. Over the past year through July 2026, its 5.6% gain outpaced over 80% of its peers.

The strategy’s adventurous mandate should support strong performance during periods of muni market strength but lead to underperformance when markets sell off. The most salient market challenges, including the early 2020 pandemic-related selloff, 2022’s bond market volatility, and the rise in muni yields in 2025’s first half, all tested the portfolio’s flexibility.

This article first appeared in the July 2026 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting this website.