Looking for tax-free returns and some of the fattest yields in the bond market? Consider funds that invest in the high-yield segment of the municipal bond market.
Attractive Investment Opportunity
Jared Woodard, BofA’s head of exchange-traded fund strategy, highlights that high-yield munis have low default rates, offering credit risk similar to that of investment-grade corporate bonds. This allows investors to capture some of the highest muni yields in recent history while maintaining credit risk control.
Yields and Risk Management
“High-yield munis offer 8% to 9% yields on a tax-adjusted basis, near the highest levels since 2017, but with less default risk than high-yield corporate bonds,” says Woodard. “You’re getting more yield for less risk. That’s a pretty compelling place to be in fixed income.”
Woodard points out that over the past year, high-yield muni ETFs experienced outflows while investors directed funds into long-term Treasury bond ETFs. However, he suggests this may not have been the most favorable decision.
Tax Considerations
With tax day approaching, it’s important to evaluate potential tax implications on your portfolio. BofA notes that corporate-bond coupon payments are typically taxed as ordinary income whether they’re reinvested or not. In contrast, most muni bond coupons are exempt from federal, and sometimes state, taxes.
Top-Rated Municipal Bond ETFs
BofA’s top-rated muni bond ETFs, each with a “1” rating equivalent to a Buy, stand out for their attractive credit exposures and above-average yields. These ETFs are:
SPDR Nuveen Bloomberg High Yield Municipal Bond ETF (HYMB)
- Tax-adjusted yield: 8.7%
- Expense ratio: 0.35%
- Total return in 2023: 7.73%
VanEck High Yield Muni (HYD)
- Tax-adjusted yield: 8.5%
- Expense ratio: 0.32%
- Total return in 2023: 6.52%
First Trust Municipal High Income (FMHI)
- Tax-adjusted yield: 6.3%
- Expense ratio: 0.70%
- Total return in 2023: 7.19%
Active vs Passive Management
While the SPDR and VanEck ETFs are passive, the First Trust ETF is actively managed. Ryan Issakainen, ETF strategist at First Trust Advisors, explains the benefits of active management in balancing risk and reward for investors.
Vanguard High-Yield Tax-Exempt Fund
Investors seeking active management in a traditional muni fund can consider the Vanguard High-Yield Tax-Exempt (VWALX) fund. With a low fee of 0.09%, this fund outperformed 92% of its peers in 2023, delivering a total return of 8.44%.
Focus on Security Selection
Nathan Will, head of municipal credit research at Vanguard, emphasizes the importance of security selection and diversification in navigating the diverse high-yield market successfully. An experienced team of credit researchers plays a crucial role in picking winning credits.
