Foreign investors continue to pile into municipal bonds at record levels.
Although they’re unable to enjoy the tax advantages of munis, non-U.S. residents still find plenty to like, as yields in much of Europe and Japan are close to zero or negative and investing in U.S. infrastructure is seen as low-risk.
As we’ve noted before (“Mythologing Today’s Muni Yields”), interest in munis by foreign investors isn’t a new phenomenon, but it’s an important point yield-seeking U.S. investors should keep in mind.
Why munis attract foreign investors
“The attractive yields of U.S. municipal bonds are proving to be attractive to yield-starved foreign investors who struggle to find comparable yields at home,” a report by VanEck said.
Foreigner holdings rose 16% in the fourth quarter of 2016 to a record $106.4 billion, according to Federal Reserve data. Though it represents a small fraction of the $3.8 trillion muni market, foreign ownership has been growing since 2000 and has spiked 32% in just the past two years.
The foundation for the surge may be traced back to 2009 and the Build America Bonds program, the report said.
Aiming to help spark the U.S. economy, Build America Bonds enabled traditional tax-exempt borrowers to issue taxable debt for municipal purposes. The program was a hit and attracted new investors – including foreigners – to the world of municipal bonds.
Foreign investors undoubtedly appreciate the peace of mind afforded by municipal bonds’ minuscule default rate. Further, the quality of investment-grade munis in many cases exceeds that of comparably rated corporate bonds and, as noted by S&P Dow Jones Indices, some sovereign bonds.
The 1970-2015 average cumulative 10-year default rate for all rated muni bonds was a mere .15%. All rated global corporate bonds, on the other hand, had a 10.16% 10-year default rate over the same time period, VanEck said.
The impact of foreign interest on U.S. muni investors
So why is strong foreign interest relevant to U.S. muni investors?
There are some investors who for years have lamented that interest rates are too low. If rates would only rise, the refrain goes, they’d just put their pile of cash sitting in money market accounts to work and dive into the muni market.
They’re still waiting.
Conjecture as to what the Fed might do and where the new presidential administration’s economic policy might be headed are interesting topics to discuss but not helpful in building a reliable stream of income.
A more productive exercise is observing the market as it is and how munis are regarded by investors – at home and abroad.
Perhaps they see something the waiters don’t.
