A tighter muni supply doesn’t mean investors can’t find the bonds they want.
In fact, supply might not be an issue at all.
More demand, fewer issues fuel tight muni supply
The story of increased demand and fewer outstanding bonds has made headlines recently. First-quarter figures show $3.6 trillion of municipal bonds outstanding, down from about $4 trillion a decade ago.
A major factor affecting supply was the tax overhaul, implemented in 2018, which eliminated the exemption on advance refunding bonds. The lack of these bonds hit the muni supply and also wiped out an important money-saving tool for state and local governments (“Reviving Advance Refunding Bonds”).
Additionally, state and local governments cut back on their issuance. Stung by the Great Recession, public officials have been reticent to take on debt, foregoing the opportunity to finance critical infrastructure needs at attractive rates (“Munis’ Looking-Glass Moment”).
While supply is contracting, investors have been pouring money into the market at prodigious rates. In fact, Lipper data going back to 1992 shows investors have bought more muni funds so far this year than at any time since the financial crisis in 2009, according to Barron’s.
Helping fuel demand for tax-free income is the limit on state and local tax deductions, another feature of the new tax law. Residents of well-known higher-tax states are snapping up munis, and residents elsewhere are pumping more funds into the market as well.
Widen the muni search
So where can investors find bonds that suit their needs?
While investors usually look for bonds issued in their home states to take advantage of the interest exemption from local, state and federal taxes, it can also make sense to consider bonds from other states. Often, even after paying these taxes, the net effect can be a higher yield.
Also, not all sectors of the bond market are shrinking. There are other corners of the market where the supply is actually growing, which makes it critical for investors to comprehensively analyze every opportunity.
Another factor
But a crimp in the muni supply and a surge in demand only partly explains why some investors remain reticent to invest. Although there are more investors pursuing fewer outstanding bonds, the real reason some people park their funds on the sidelines is because they think they can’t find value amid relatively low yields.
Behind this idea, of course, is the fairy tale that it’s possible to time the market and jump in when yields spike. Meantime, as they weigh these impossible-to-know factors, their hesitancy is costing them money, as they’ll never make up the tax-free income they sacrificed.
There are more than 50,000 different issuers. For investors seeking tax-free income, the issue isn’t a shortage of bonds. It’s much simpler: They’re not always looking in the right place.