Benefits and risks of investment in municipal bonds

The reports from Invesco suggest EU based investors are seeking US municipal bonds for diversification to get risk adjusted returns.  These have played a significant role in infrastructure development since 1800 as the money from these bonds is spent on local, state or national level projects.  The buyers of these bonds directly invest in the infrastructure projects.

Advantages

These are high-rated investments as compared to most of the corporate credits. Currently, majority of municipal bonds are rated A, even as, only a few (approx 25 per cent) of the corporate bonds are given rating A.

The key feature of the investment is that it requires a low capital to start and offer longer duration opportunities; typically, more than 20 years where buy and hold strategy applies.

Investment advisors recommend buying municipal bonds by the end of the year, the time when the Fed is expected to announce the rate hike. During this time institutional investors are less likely to buy these as the corporate tax reduced from 35 per cent to 21 per cent and the low taxes make these securities less attractive.

A balanced portfolio can provide protection against rate hikes and reduce pressure on bond prices.

Some believe the ones with longer duration maturities such as the 15 year maturities can be blended with the shorter duration bonds to get higher yield.  

Risks

These are safe fixed investment opportunities that can be traded cheap for tax revenue support gains.  There are many factors; the investor should carefully analyse to invest such as services, the local demographics, management reports etc.  One may not get insurance for most high yield munis bonds, but, even in case the investor gets insurance, the risks are high. Some of these are private activity bonds and are not tax free.  These can be state free or federal free, and the earnings from these bonds are counted as taxable.

These are affected by debt crisis such as the Puerto Rico debt crisis; hence, the investor should select the best from the various munis options.

Banks reduced exposure

Tax reforms affect munis returns but long-term are still beneficial. Some banks reduced exposure to state and city debt after the announcement of cut in corporate tax rates.

BOA, Citi, JPMorgan Chase, State Street, Wells Fargo reduced their holdings of bonds by $16 billion in the first six months of 2018.

JPMorgan cut $3.5 billion, Wells Fargo $3.9 billion and State Street slashed $4.9 billion in the first six months of the year 2018. Two banks increased their exposure in the same which includes Goldman Sachs and US bank.

This was for the first time that banks reduced their exposure to such tax exempt options, since 2009, mostly due to the government’s decision to reduce tax benefits on these securities. Barclay claimed in the first three months of the year, the banks reduced their exposure in Municipal bonds by more than $15 billion, and later, the reduction in these municipal debt bonds was nearly by $6 billion in the Q2 as reported on August 10. Banks may continue to reduce their exposure in the scheme and invest in other attractive options.   

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