Finding Muni Bonds That Make Sense

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

Is finding the right municipal bonds as easy as throwing darts at a board, or as treacherous as standing in front of one?

According to the pundits, municipal bond investors are facing either one of those extremes today.

But as decades-long veterans of the muni market, we know there’s more to finding muni bonds that make sense for investors.

Finding Muni Bonds That Make Sense

Dizzying array of voices

Over the past few months, the economic fallout from COVID-19 ignited volatility in the muni market. Naturally, the pundits weighed in, and their takes ran the gamut.

Some sounded apocalyptic, breathlessly warning of overstretched state and local governments bursting from the added burden of pandemic-related costs.

One had a fantastical view of the pre-pandemic market: “It was almost as if investors could throw darts on a board of municipal bonds and wherever it landed was deemed a safe investment.”

Although things had changed, he said, there’s still plenty to be optimistic about and the best way forward is through… laddering!


Reality behind the hot takes

First, it’s never a good idea to randomly select municipal bonds. Yes, the default rate on munis is infinitesimal, but it’s always imperative investors know and understand the specific attributes of the bonds they’re buying.

And laddering? It’s a disproven strategy that has never worked (“The Laddering Delusion”).

Still, aren’t current events unsettling the market? We’re not soothsayers, so we can’t know how the innumerable factors that affect municipal bonds will fare in the future, but a doomsday scenario seems overblown.

Let’s look at some facts.

The Fed is behind the economy and has established a special loan facility for struggling municipal issuers. The fiscal footing of state and local governments is stronger than it was a decade ago during the Great Recession. Further, the health of bond insurers gives us some comfort.

For example, the top two insurers, Assured Guaranty and Build America Mutual, continue to write new business.

“Assured Guaranty continues to write new business in both the new issue and secondary markets, and we look forward to providing value and security for issuers and policyholders in these challenging times,” the company said in a statement last month.

Assured, with more than $11 billion of claims-paying ability, noted its insured portfolio leverage improved by 59% since September 2009, and said it is positioned “well to manage any potential negative impact from the COVID-19 pandemic.”

BAM also is continuing to approve new credits for insurance and has maintained its underwriting criteria. It says it has adequate liquidity to pay claims during COVID-19 related economic disruptions.

“BAM monitors upcoming payments due on all of its insured transactions to ensure it will have adequate liquidity to meet all of its needs.”

Finding muni bonds that make sense

So if the muni market isn’t on the extremes as the pundits suggest, how should investors proceed?

The same way they always have: Prudently.

When evaluating the merits of a bond, focus on quality first, then yield. Start with the question, “How will I be repaid?” Examine the source of revenue that will pay your tax-free income. This information is readily available and professionals are available to help.

Those are the principles tax-free bond investors have always relied on. It keeps their tax-free income flowing and lets them sleep well at night.

James A. Klotz is the President of FMSbonds, Inc.
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Jun 22, 2020

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.