Taxable municipal bonds are appealing for their yield, income, and credit strength. Many investors are unaware of this asset class which is unfortunate given it is compelling and they might benefit from it. Did you know that BBB munis have the same level of credit strength as AAA corporates according to a recent Moody’s study? Did you also know that BBB taxable munis yield far more than AAA corporate bonds even though the credit risk is about equal? You may earn far more yield with similar credit history. Strange but true. This risk-adjusted yield improvement is one of the appealing oddities of the municipal bond market. It is inefficiencies like this which we seek to identify for our clients’ benefit.

The following chart shows various yields for A – AAA taxable municipal bonds and AAA corporate bonds. The AAA corporate curve is the white line and it provides the lowest yields on the chart inside of 7 years and one of the lowest through 15 years. One may expect this since it is AAA and deemed safe paper. What you may not expect is AAA corporates also have the highest default rate on this chart. Every other curve on this chart (A - AAA rated taxable munis) not only have better yields, they are empirically safer from a credit standpoint by virtue of their lower default rates compared to AAA corporates.

yields for A – AAA taxable municipal bonds and AAA corporate bonds

If you are investing in corporate bond mutual funds or ETFs in your brokerage accounts or tax-deferred accounts (IRA’s, pensions, etc), we suggest you consider taxable municipal bonds as a replacement or a complement. This asset class provides stronger risk-adjusted returns (as measured by yield for unit of credit risk), high coupons (4-7% on average), and our ability to consistently find strong yield value in addition to the above yield levels is possible through our on-going process of bidding bonds at below market values. You may pick up more yield, earn higher coupon streams, and improve the overall credit strength of your portfolio with taxable munis.

In case you were wondering about the highest yields on the above chart, the red line, these are single-A rated taxable municipal bond unlimited GOs which are backed by ad valorem property taxes and include Syracuse NY GOs, Cumberland MD GOs, and Olivia MN GOs. This bond rating class has a historical default history of 0.07% which is 1/5th of the default rate found in AAA corporate bonds. We love the municipal bond market for inefficiencies like this.

Greg Lavine, CFA, CFP®

(sources: Bloomberg BVAL curves and Moody’s 2016 default study p 23)

Past performance is not indicative of future results