We believe that the municipal bond market is now poised for a positive year-end finish, following a generally difficult 2018. A look at the fundamentals going into December help make the case for investors to consider both reengaging the tax exempt bond market and positioning in the intermediate part of the investment grade yield curve.
Intermediates sold off this year due, at least in part, to changes resulting from the passage of the 2017 Tax Cuts and Jobs Act. After adjustments in the market, we believe they now offer attractive entry points from a yield perspective.
The VanEck Vectors® AMT-Free Intermediate Municipal Index ETF (NYSE Arca: ITM®) offers investors exposure to this opportunity. The ETF is designed to track the intermediate-term tax-exempt bond market. As seen in the chart below, currently, AAA-rated muni to U.S. Treasury yield to worst ratios are above their long-term average going back to 2003. Therefore, we believe that ITM, which is only 20% in AAA bonds, may be a more attractive yield play than investors realize.
Ratio of AAA Municipal Index1 Yield to 10-Yr U.S. Treasury Yield 12/31/17 - 10/31/18
Source: FactSet. Data as of 11/28/2018.
1Bloomberg Barclays AAA Municipal Bond Index is a rules-based, market-value-weighted index measuring the non-investment grade and non-rated U.S. tax-exempt bond market.
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Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer’s financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Bonds and bond funds will decrease in value as interest rates rise. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. Municipal bonds may be less liquid than taxable bonds.
The income generated from some types of municipal bonds may be subject to state and local taxes as well as to federal taxes on capital gains and may also be subject to alternative minimum tax.
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