Municipal bonds: a heritage of yield, stability and diversification | Insight Investment

Municipal bonds are a mainstay for investors seeking stable, high quality and tax-advantaged investment income. They have a long history of predictable returns and diversification against risk assets. 

Municipal bonds have a history of compelling yield

In 1812, New York City issued the first municipal bonds to finance a canal. Over 200 years later, municipal bonds are a $4trn market and a backbone of US infrastructure finance, helping build public necessities like roads, bridges, airports, hospitals, schools, power plants.

Investors have been keen to play their part. A major benefit is that municipal bond income is frequently exempt from federal and state-level taxes, which has consistently helped keep after-tax municipal yields above US corporate and US aggregate bonds for those subject to higher tax rates (Figure 1).

Figure 1: Municipals have provided investors with attractive, high-quality yield¹

Municipal bonds have offered high grade credit quality despite higher yields

Despite often higher tax-equivalent yields, municipals bonds have an average credit rating of “AA”, the same as aggregate bonds and superior to investment grade US corporate bonds, which average A-/BBB+¹.

Many municipals have executed prudent debt and budget management and accumulated high cash balances over the last few years. Investment-grade municipal bonds have a cumulative 10-year default rate of 0.09%, versus 2.17% for investment-grade corporates².

Municipal bonds may also provide compelling diversification against other fixed income, given historical correlations (Figure 2). 

Figure 2: Municipals have often displayed lower correlation against other bonds than those markets have against each other³

Municipals may offer yield, resilience and diversification

We believe municipal bonds have a history of compelling yield, resilience and diversification to investment portfolios. Their long history, robust credit profile, and critical role in public infrastructure finance underscore the market’s key role in the economy.

In our view, municipal bonds continue to be a compelling choice for investors seeking stability and income in an uncertain medium and long-term environment.