The search for tax-free yield

Investors in search of stronger yields should consider an often-misunderstood sector: high yield municipal bonds. High yield municipal bond funds tend to have long average maturities and thus are subject to interest-rate risk — but they don’t correlate with Treasurys as much as investment grade municipals, adding some diversification and yield. It is also important to note that income is the most significant component of total return over time, while price change is highly volatile and less significant. As the chart below shows, adding high yield municipal bonds to an investment grade municipal portfolio may significantly increase yield while having minimal effects on interest rate risk.

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Source: Data from Barclays Live, as of March 31, 2018.

*Represents Yield to Worst (YTW) for each scenario

What this means for investors

Adding an allocation to high yield municipal bonds in your portfolio may be an attractive way to add yield while adding incremental interest rate risk. For example, looking at the chart above, which is based on index data as of March 31, 2018, you can see that a 10% allocation to high yield municipals led to a 2.94% yield to worst, compared with a 3.97% yield to worst for a scenario with a 50% allocation to high yield municipals.

Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt. The Fund may also be subject to prepayment risk, the risk that the principal of a bond that is held by a portfolio will be prepaid prior to maturity, at the time when interest rates are lower than what the bond was paying. A portfolio may then have to reinvest that money at a lower interest rate.

High yielding, non-investment-grade bonds (junk bonds) involve higher risk than investment grade bonds. The high yield secondary market is particularly susceptible to liquidity problems when institutional investors, such as mutual funds and certain other financial institutions, temporarily stop buying bonds for regulatory, financial, or other reasons. In addition, a less liquid secondary market makes it more difficult for the Fund to obtain precise valuations of the high yield securities in its portfolio. Duration is a measurement of the sensitivity of a bond’s price to a 1% change in interest rates, given the bond’s coupon rate and maturity.

The Bloomberg Barclays 3–15 Year Blend Municipal Bond Index measures the total return performance of investment grade, US tax-exempt bonds with maturities from 2 to 17 years.

The Bloomberg Barclays High-Yield Municipal Bond Index measures the total return performance of the long-term, non-investment-grade tax-exempt bond market. Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index.


Investing involves risk, including the possible loss of principal.

Past performance does not guarantee future results.


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