An Active Municipal Bond ETF Approach for Fixed-Income Investors Seeking Quality

As we consider the macroeconomic outlook, fixed income investors can find opportunities in the municipal bond ETF market during these unprecedented times.

In the recent webcast, Navigating Today’s Dynamic Market Environment with Active Municipal Bond Fund Management, Joseph Gotelli, vice president and senior portfolio manager at American Century Investments, noted that while the municipal bond market was not immune to the pullback across the fixed income space this year, the munis segment remains robust. For example, munis have rarely defaulted, with Baa-rated corporates exhibiting over three times the likelihood of defaulting when compared to the same Baa-rated municipal securities.

Meanwhile, municipal bond credit trends remain strong. For instance, in the latest Q3 2022, upgrades as a percentage of rating revisions were 75% while downgrades as a percentage of ratings revisions were 25%.

"Municipal Credit Trends remain strong due to strong revenue growth, unexpended Federal COVID-19 relief funds, and record reserve levels, including rainy day fund reserves," Gotelli explained.

Municipalities are also safely funded with no signs of reneging on their obligations. State general fund reserves are at record levels. According to the National Association of State Budget Officers (NASBO), states finished FY 2021 with $234.7 billion in total reserves or 25.4% of expenditure, and rainy day funds were $124.5 or 13.5%.

Fundamentals may also help support the muni bond outlook. Specifically, Gotelli noted that the supply of new municipal bond issuance has significantly declined year-over-year.

Investors who are also looking into the municipal bonds market can turn to something like the American Century Diversified Municipal Bond ETF (NYSEArca: TAXF) to capture this fixed income segment. TAXF is an actively managed municipal bond fund that combines investments in thoroughly researched high-yield and investment-grade municipal bonds. Designed for investors who are seeking current income, the fund dynamically adjusts investment grade and high-yield exposures based on prevailing market conditions.

Gotelli explained that the fund draws on the same expertise and stable investment team as employed by American Century mutual funds. The municipal bond exchange traded fund seeks consistent tax-free income and dynamically allocates to investment grade and up to 35% high yield to take advantage of prevailing market conditions. It also employs an active, time-tested process designed to identify attractive issues with low default risk, and aligns risk exposures with highest-conviction ideas.

The ETF strategy identifies municipal securities which seek to provide higher value relative to their credit fundamentals. In addition, issuer selection is carried at the sector level independently within investment grade and high yield to avoid concentration risk.

Looking ahead, Gotelli argued that return expectations are improving given markets have priced in significant rate increases. The municipal relative value to Treasuries is close to fair value with the long end of the curve reflecting the most value. Meanwhile, fund flows are expected to remain volatile until total returns stabilize. Investors may find attractive tax-exempt yields that are expected to be a tailwind to demand from retail. In this type of environment, investors may seek to tilt towards higher-quality issuers/sectors, while remaining focused on security selection in lower-rated exposures.

Financial advisors who are interested in learning more about the municipal bond market can watch the webcast here on demand.


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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