Why are muni fund yields so low?

Tarwheel

Yields on all of my bond funds, except munis, have steadily increased over the past year. My taxable bond funds are all yielding well over 5%, and of course, you can easily capture yields over 5% with CDs, short term bond funds. Even money markets are approaching 5%. However, my pitiful muni funds are not yielding much more than 3%. Unless you are in a high tax rate, I can see no benefit to owning munis right now. I don’t understand how this situation transpired. Why haven’t muni yields risen proportionally like other bond funds? They dropped in value, like all bond funds, in response to rising interest rates, but they don’t seem to be increasing their yields this year like taxable bond funds.

Tarwheel

BTW, I understand that muni yields are almost always lower due to their tax advantages. However, I’ve never seen such a spread between the yields of munis and taxable bonds.

hank

Good question. These things run in cycles. I’m in a similar situation. Short / intermediate term stuff. Down in ‘22 and up a bit this year. Treading water for 18 months now. I’m prepared to wait it out. But your point is valid. Agree that for many of us it’s a toss-up in terms of tax advantage, One could probably over analyze this and come up with various political / macroeconomic / social reasons why munis have underperformed. But I haven’t seen anything convincing in the press. For every detractor I read today, there’s someone else who sees opportunity in munis. So it goes.

Sorry I haven’t answered your question.

Crash

HYMU
YTD +2.87%.
1-year: -4.8%
YIELD: 4.21, a respectable neighborhood.

It's not lighting the world on fire, but better than the 3% you mentioned. I don't own it. I track it, for the sake of reference. I have no practical use for munis. "Break a leg."

yogibearbull

Munis are good for high federal tax brackets; there could be high state tax in addition. So, look at effective/tax-equivalent yields. Barron's had a recent piece that munis now have tax-equivalent yields of 5-8% and are attractive. They are useless for lower tax brackets.

Tarwheel

My wife and I have been in the 12% tax bracket but will probably bump up to 22% this year. Even so, the tax-equivalent yields on our muni funds (FTABX and FLTMX) were competitive with taxable bond funds and CDs until the past year. Now the spreads are so large that our muni fund yields are not competitive even at the 22% rate (and I presume 24%).

Sven

Addition to being tax-exempt for federal tax, state-specific muni funds are also exempt from state tax too. For those who are in high tax brackets and living in states with high state tax, they would most benefit after taxation. The “double” exemption is attractive for these high income tax payers.

As @yogibb mentioned above, one needs to compare the effective tax yield specific to their tax brackets in order to make that determination.

hank

The one I have plays in the upper tier of the high yield market. When I bought it I assumed (perhaps incorrectly) that these might be a tad superior in quality (likelihood of getting repaid) compared to corporate HY. I can’t verify that. But it helps explain my thinking a little. Not disappointed. Like most everything else held, these fluctuate in price. And, most bonds got clocked in 2022.

I’ve spent couple hours looking at possibility of including 10 year or longer Treasuries as an additional market hedge. But can’t bring myself to do it. Too many unknowns. Today, the 10 year popped back above 4%. The VIX is beginning to creep upward too. Still very low at 14.

msf

It used to be that munis had less credit risk than taxable bonds with equivalent credit ratings. That is, a BBB muni was as safe an A-rated taxable bond. This all changed a dozen years ago when muni ratings were "recalibrated". Now, the risk of an A rated muni is similar to the risk of an A rated corporate.

This recalibration may have been more significant for investment grade munis, but some HY securities were affected as well.

Fitch: https://www.fitchratings.com/research/us-public-finance/fitch-announces-recalibration-of-us-municipal-bond-ratings-25-03-2010

Moody's: https://investorrelations.hawaii.gov/dhhl/wp-content/uploads/sites/4/2014/02/Moody_Rating_Implementation_Guidance.pdf

FD1000

https://seekingalpha.com/article/4622176-nhmax-way-to-add-duration-and-yield-high-tax-payers?mailingid=32261069&messageid=2850&serial=32261069.1494&utm_campaign=rta-author-article&utm_medium=email&utm_source=seeking_alpha&utm_term=32261069.1494

hank

Good article from FD.

Not mentioned in the article, but as a citizen investing in municipal bonds makes me feel good to see my money being put to work building schools, bridges, libraries and the like. So I’ve been bitten a little recently. But at least the $$ is going to fund good things …

Crash

FD1000 said:

https://seekingalpha.com/article/4622176-nhmax-way-to-add-duration-and-yield-high-tax-payers?mailingid=32261069&messageid=2850&serial=32261069.1494&utm_campaign=rta-author-article&utm_medium=email&utm_source=seeking_alpha&utm_term=32261069.1494

"Unlock this article with PREMIUM service." Nope.
https://www.morningstar.com/funds/xnas/nhmax/quote

hank

Crash said:

FD1000 said:

https://seekingalpha.com/article/4622176-nhmax-way-to-add-duration-and-yield-high-tax-payers?mailingid=32261069&messageid=2850&serial=32261069.1494&utm_campaign=rta-author-article&utm_medium=email&utm_source=seeking_alpha&utm_term=32261069.1494

"Unlock this article with PREMIUM service." Nope.
https://www.morningstar.com/funds/xnas/nhmax/quote

I can’t usually read SeekingAlpha. But, Apple was able to get me in the door here without my having to hand over any personal info. Of course “In Apple I trust.” Really is a good article touching on both munis and corporates. Speaks positively about munis from a current investment standpoint.

FD1000

I never paid a penny to SeekingAlpha but I can read many articles.

Gary1952

yogibearbull said:

Munis are good for high federal tax brackets; there could be high state tax in addition. So, look at effective/tax-equivalent yields. Barron's had a recent piece that munis now have tax-equivalent yields of 5-8% and are attractive. They are useless for lower tax brackets.

Not so useless if you are taking income and doing Roth conversions or RMDs. Why add tax burden to SS? Inherited money needs to go into taxable account. Why add tax burden there, especially if you are taking RMDs?

msf

Taking income and doing Roth conversions are just two of many ways that you could wind up in a high tax bracket. Another way is simply getting paid a lot of money. Taking IRA distributions (whether for RMD or for other reasons) is likewise just another way to wind up in a high bracket.

What matters is your effective tax bracket, not how you get there.

Then there are quirks in the tax rules that distort tax brackets. For example, if some but not all of your capital gains are taxed at 0% because your taxable income is low enough, then every dollar of ordinary income you add will likely cost you an extra 37¢ in taxes. That's 15¢ tax on a dollar of cap gains that used to be taxed at 0% plus 22¢ on the extra dollar ofordinary income. So your effective tax rate is 37%, even though you are nominally in the 22% bracket.

Again, why that extra dollar of income is taxed the way it is doesn't matter. All that matters is whether that last dollar of income gets taxed a lot (high effective tax rate) or a little (lower effective tax rate). If the effective rate is not high enough, munis are useless.