Municipal bond opportunity amid climbing rates
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Hi, everyone. Thanks for joining us today. I’m Jonathan Forsgren, and here with me is Jason Diefenthaler, head of Tax-Exempt Strategies for Schwab Asset Management.
Jason, 2022 has been an extremely challenging year for bond investors, with 40-year highs in US inflation and the most aggressive rate hikes we’ve seen from the Fed since the mid 1990s. So what are your thoughts on forward-looking opportunities for municipal bonds?
Yes, that’s all definitely the case. This year has seen a sharp increase in inflation and interest rates, and as you noted, the hawkish Fed. So this has all created challenges for munis for much of 2022. But from where we sit, these challenges have also created opportunities, and for investors that are in high federal and state tax brackets, we’re now seeing taxable equivalent muni yields in excess of 7% across many areas of the market. So if you’re an investor looking for income, that’s great news. And the performance outlook going forward is probably the brightest that we’ve seen in more than a decade.
So despite all this volatility, things look good. Credit conditions across the state and local governments remain very solid, tax receipts have surged across the country, reserves have gotten stronger. And that’s worth noting as we think about a slowing economy and growing recession risks because municipal bond defaults have been far fewer and further between when compared to corporate bonds during past recessions.
It’s always nice to hear an upbeat outlook, Jason. So for advisors interested in considering muni bonds for their clients, how might these securities be used for asset allocation purposes?
That’s a great question. You know, we think municipal bonds can be an attractive solution for a wide range of scenarios. I’d mentioned two common ones, in particular. First, munis can be a great solution for clients seeking current income, especially for those that are in higher tax brackets, since munis can deliver income that’s potentially tax-free at both the state and federal level. And, second, the broader muni market has historically shown a near zero correlation with the S&P 500 Index. That means that municipal bonds can be an attractive equity diversifier across a balanced portfolio. Of course, asset allocation decisions for any client should be matched with their specific risk profile. That’s where advisors play a pivotal role.
Those sound like smart allocation opportunities, but buying individual bonds can be a complex, research intensive process. How else can advisors add munis for clients?
Well, mutual funds, ETFs, those are two of the most popular investment vehicles in the market. They’re both pooled vehicles. They’re typically designed to give investors broad diversification within an asset class or a specific sector, and they do so quickly and efficiently. They also tend to have low investment minimums, they tend to be liquid, and proceeds from a liquidation are often available within one business day. That said, there are some important ways in which ETFs and mutual funds differ. I’d point to ETFs offering potentially greater transparency and tax efficiency.
Speaking of ETFs, Jason, congratulations on the recent launch of the Schwab Municipal Bond ETF, ticker SCMB. What should advisors keep in mind regarding this new ETF?
That’s right, we launched the Schwab Municipal Bond ETF in October. Our goal in launching this muni ETF was simple, to provide investors with a low cost, diversified approach to the tax-exempt bond market. The ETF seeks to produce income that’s potentially exempt from federal taxes and also not subject to the alternative minimum tax, which are both important features. And with a net expense ratio of three basis points, our ETF has the lowest fee in its respective Morningstar Lipper peer group categories. And it’s also worth pointing out that Schwab Asset Management is the fifth largest ETF provider, with more than a decade of managing ETFs.
Well, Jason, thanks for sharing your thoughts on the opportunities in the municipal bond market and how munis might fit within an asset allocation framework. And congratulations, again, on launching the new low cost Schwab Municipal Bond ETF, ticker SCMB. And to our viewers, thank you for watching. For AssetTV, I’m Jonathan Forsgren. Before signing-off, please take a moment to review the disclosures that follow.
Jason Diefenthaler, Head of Tax-Exempt Strategies for Schwab Asset Management™, shares his views on opportunities in the municipal bond market during an environment of climbing interest rates.
To assist advisors who are interested in adding munis to their clients’ portfolios, Jason discusses asset allocation considerations as well as the benefits of pooled vehicles, which are an alternative to the complex, research-intensive process of selecting individual bonds.
Jason concludes by sharing the key features of the recently launched, low-cost ETF, the Schwab Municipal Bond ETF (SCMB).