4 Factors Why Muni Bond ETFs Could Rally

Muni bond ETF investing may come to the limelight all over again in the coming days. The segment underperformed thanks to the rising rate trends and historically rich valuations. But there are a few factors that could brighten the struggling space in the near term. Below we highlight those factors.

Democrats’ Tax-the-Rich Plan

President Biden’s plan is to hike the corporate tax rate to 28% from 21%. Biden is also proposing to levy a minimum tax rate of 15%. Increasing the top tax rate to 39.6% from 37% for individuals making over $400,000 has also been proposed by the President. Such a step, if it materializes, would boost the apparent tax-haven muni bonds (read: ETFs to Follow If Tax Hike Comes After $1.9-T Biden Stimulus).

These bonds are excellent choices for investors seeking a steady stream of tax free income. Usually, the interest income from munis is exempt from federal tax and may also not be taxable per state laws, making these especially attractive for investors in the high tax bracket looking to reduce their tax liability.

Improving U.S. Economic Growth

The peak of the pandemic was worrying for muni bonds.Since entities like airports, schools and colleges were closed during the lockdown, munis were severely hurt. Lower levels of tax collections were a concern. But now, with economies reopening on the heels of better COVID-19 metrics, widespread vaccination lowering health risks, and fiscal stimulus boosting consumers’ financial health, munis have a brighter outlook.

In any case, bonds backed by states and cities have the lowest default risks, “since governments have the ability to raise taxes and bond payments make up a relatively small share of their budgets,” per the article published on Bloomberg.

No state has defaulted since the Great Depression. “Since 1970, only about $72 billion of the municipal bonds rated by Moody’s Investors Service defaulted, with about $66.5 billion of that from the bankrupted governments of Detroit, Jefferson County, Alabama, and Puerto Rico,” according to a report from investment firm VanEck,” as quoted on a Bloomberg article last year.

Biden’s Plan May Boost Build America Bond Issuances

Biden’s recently announced hefty infrastructure plan requires about $6 trillion over the next 10 years. Democrats are believed to be relying on an Obama-era tool to finance their infrastructure plan: Build America Bonds (BABs) (read: ETFs to Win on Biden's Infrastructure Plan).

“BABs are special municipal bonds that allow states and counties to float debt with interest costs subsidized by the federal government. That underwriting not only served to ease jittery investors in the aftermath of the financial crisis, but also made municipal debt even more attractive with rates sometimes north of 7%,” as quoted on CNBC.

Vikram Rai, head of Citi’s municipal bonds strategy explained that “increasing the corporate tax rate or implementing a carbon fuel tax — even those very marginal tax increases will be more than enough to fund the initial outlay of infrastructure projects” and help the federal government underwrite BABs. So, demand and supply of BABs may be abundant in the coming days as increased issuance always doesn’t prove to be detrimental if other factors remain favorable.

Higher Yields

Rates are normally higher in muni bonds than treasuries. Nine-year New York state personal-income-tax debt rated AA+ traded on Apr 6, 2021 at an average yield of 1.25%, or 29 basis points more than AAA rated bonds, per Bloomberg (read: 5 ETFs to Tap to Earn At Least 4% Yield & Capital Gains).

“Spreads are still way too wide for what are very, very stable, if not strong credits,” said Andrew Clinton, chief executive officer of Clinton Investment Management, who has made New York state and local muni debt the largest position in client portfolios. “Investors currently have not priced in any of the risk of potentially higher taxes, either at the federal level and certainly not at the state level,” as quoted on a recent Bloomberg article.

ETFs in Focus

Against this backdrop, below we highlight a few muni bond ETFs that offered decent returns past month with decent yields.

Rareview Tax Advantaged Income ETF RTAI – 1.69% Return; 0.99% Yield

First Trust Municipal High Income ETF FMHI – 1.01% Return; 3.33% Yield

Columbia Multi-Sector Municipal Income ETF MUST – 0.66% Return; 2.25% Yield

VanEck Vectors Short High-Yield Municipal Index ETF SHYD – 0.51% Return; 3.02% Yield

VanEck Vectors AMT-Free Long Municipal Index ETF MLN – 0.50% Return; 2.64% Yield

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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