Municipal bonds experienced a significant downturn, posting a negative return of 6.35% in the third quarter, the worst since 1981, primarily due to a sharp increase in interest rates rather than credit issues, according to Nuveen. As bond prices fell, yields rose, with the Bloomberg Municipal Bond Index reaching 4.78% at the beginning of October.
This situation creates an attractive opportunity for high-income investors, especially those in higher tax brackets, as municipal bonds offer tax-free income at the federal level and often at the state and local levels as well. For instance, a municipal bond yielding 3.5% is equivalent to a taxable bond yielding 5.45% for an investor in the 32% federal tax bracket.
Closed-end funds, which trade on exchanges and can offer higher yields, are one way to access this market, although they come with higher fees and risks due to leverage. Nuveen's Quality Municipal Income Fund (NAD) has an 8.2% distribution rate, while BlackRock's MuniHoldings Fund (MHD) offers a 6.79% distribution rate, both trading at discounts to their net asset values.
Financial advisors caution that while these funds can provide substantial tax-exempt income, they also carry risks that may not suit every investor's objectives, particularly retirees focused on income and risk management.
For those preferring a simpler approach, building a laddered portfolio of municipal bonds or investing in ETFs like Vanguard's Core Tax-Exempt Bond ETF (VCRM) can offer diversification, although investors must remain vigilant about interest rate fluctuations.
Overall, this period presents a unique opportunity in the municipal bond market, as highlighted by industry experts like Matthew Wrzesniewsky from Vanguard