BlackRock is finding solid tax-free yields in this corner of the bond market
Investors seeking tax-advantaged yield can still find some solid opportunities, but they’ll need to be selective, according to BlackRock’s Patrick Haskell. Municipal bond issuance is on pace to exceed $580 billion this year, according to BlackRock. At the same time, flows of new cash into muni bonds hit $56.6 billion in the first half of the year, the second-best start to any year, the firm found. “The key for the second half will be patience,” said Haskell, head of the municipal bond group at BlackRock. “There will be opportunities, but you want to buy the right credits, the right structures and the right levels. We are cautiously optimistic in the second half.” A favorite among wealthy investors Municipal bonds are a favorite of the high-income crowd. Generally, they are safer than their corporate counterparts, as they tend to be backed by the full faith and credit of the taxing authority. Though their nominal yields are lower than corporate bonds, they offer income that’s free of federal taxes – and investors who live in the issuing state may also receive income that’s exempt from state and local levies. Tax-free yield is more valuable to individuals in higher income brackets. An individual who’s in the 32% federal tax bracket and subject to the net investment income tax would have to find a taxable bond yielding 5.45% to generate the same income they’d get from a 3.5% tax-free muni bond. Preferred muni bond sectors at BlackRock Haskell’s team is staying neutral on duration but continues to like parts of the long-end of the muni bond curve, including those in the 20- to 22-year range. The risk with these longer-dated issues is that their prices are more sensitive to fluctuations in rates – known as duration risk. “If you want to take duration risk, you’ll want to do it in muni bonds because you get compensated for that risk,” he said. Haskell’s team is also staying high in quality and coupons, trimming lower-coupon exposures in favor of those that are upward of 5% that the firm thinks are better poised to handle periods of market uncertainty. In particular, Haskell’s team likes revenue bonds, particularly in the housing and transportation sectors. These bonds are issued by public agencies but are backed by dedicated revenues from certain projects, like housing developments or toll roads. The S & P Municipal Bond Housing Index has a yield-to-worst of 4.34% — or a tax-equivalent yield of 7.33%, assuming an investor who’s subject to a 40.8% effective tax rate. The yield-to-worst yardstick measures the lowest potential yield a bondholder would receive short of an issuer going bankrupt, and incorporates early retirement dates, like call or put options. Meanwhile, the S & P Municipal Bond Transportation Index has a yield-to-worst of 4.06%, or a tax-equivalent yield of 6.86%. Haskell also likes select corporate-backed municipal bonds. These bonds are issued by a government but backed by a corporation, and can involve industrial development or pollution control projects. The S & P Municipal Bond Corporate-Backed Index has a yield-to-worst of 4.39%, or a tax-exempt yield of 7.42%. “I will tell you that munis in general are in a good situation,” Haskell said.
