Muni Bonds: Tax & Safe High Yield? (NYSEARCA: MUB)
2022 has been downright terrible for bond investors. At least it had been. Fixed income securities have actually provided some weight to a balanced portfolio over the past two months. Consider that since late April, the iShares Aggregate Bond market ETFs (AGG) posted a positive total return while the SPDR S&P 500 ETF (TO SPY) is down more than 7%. Bond yields could have set a short term top for now.
Short-term bond market returns are positive as the stock market fell sharply
ETF performance year-to-date: Lower bond prices mean better yields to maturity today
A MUB beating to start 2022
I see some particularly interesting price action in the iShares National Muni Bond ETF (NYSEARCA:MUB). After enduring the worst start to the year through April since its inception in 2007, the muni bond market has come back strong from its May nadir. Yet there is still a long way to go before an investor can make up for the principal losses from the sharp rise in interest rates until 2022 kicks off.
Here’s the rub on MUB
So what exactly is the MUB ETF, you might be wondering. It is a low-cost index fund that tracks the investment results of an index composed of high-quality US municipal bonds. This means that only high quality mounded bonds are included in the MUB, so the credit risk is quite low. Investors should be more concerned about interest rate sensitivity. According to iShares, the ETF has an effective duration of 6.02 years, meaning that for an instantaneous 1% rise in interest rates, the fund would lose 6% in value. Of course, its net asset value would increase by this amount if rates fell.
A 1% year-over-year rate hike would lower total yield by 2.9% for US munitions
MUB: A (legal) tax haven!
What makes municipal bonds attractive, however, is that they are tax-exempt. For an investor in the top marginal tax bracket of 37%, an average yield to maturity of 2.92% on MUB corresponds to a tax equivalent yield of 4.63%. This is a far cry from the paltry returns seen just six months ago.
Characteristics of the MUB: High yield in fiscal equivalence
Much better returns for tax-sensitive fixed income investors
According to Bank of America Global Research, municipal bond yields have returned to solid levels – the highest since the brief bond market sell-off seen during Covid in March 2020. at worst close to 4%, much less rate sensitive issues can be held with a still strong YTW of 3%.
A Contrarian Indicator: Three-Year Rolling Yields Have Turned Negative
BofA has more information – for only the second time since late 1995, three-year yields turned negative in mid-May for muni bonds. Effectively, this is when buyers stepped in, pushing prices up and driving yields down.
Additionally, the US Municipal AAA Yield Index has found resistance near the 2.6% level over the past decade – this could be a good time to dive into the MUB based on this technical trend.
AAA Muni yields tend to peak near 2.6%
A big five-day bounce
In the past few days alone, MUB has seen a wave of buying. The fund is up a massive 2.5% in just five days. That might not seem like a lot, but it’s a massive move, as seen in the “Rate of Change” chart above the price chart below. There has also been a flood of MUB stock volume this month – a sign of a possible trend reversal.
MUB: big drop in 2022, but a recent rebound on a large volume
Municipal bonds now yield nearly 3% while offering a tax-equivalent yield of more than 4.6% for people in the highest marginal tax brackets. Investors should do their own tax research to see if owning this fund makes sense, but MUB can be a decent place to park short-term cash for high-income taxpayers looking for a good income. . I like the bullish turn we’ve seen in MUB, and even if rates rise from here, YTM is strong enough to offset some of those possible major losses.