Municipals: Outperforming corporate fixed income with lower default risk

Municipals: Outperforming corporate fixed income with lower default risk

Historically, municipals have experienced fewer defaults than corporates across the credit spectrum. Defaults also highlight a significant contrast between the high yield and investment grade markets.

If we examine the issuer default history of Moody’s-rated debt going back to 1970, which shows a significant increased risk of default for investors in BBB-rated and below-investment-grade taxable issues versus comparably rated tax-exempt issues, we see a much stronger credit profile for municipal bonds.

Municipal rated debt vs. corporate rated debt

10-year average cumulative issuer-weighted default rates

Moody’s-rated debt only (1970-2022)

Municipal rated debt Corporate rated debt
AAA 0.00% 0.34%
AA 0.02% 0.75%
A 0.10% 1.90%
BBB 1.05% 3.64%
Below investment grade 6.84% 29.81%

Sources: Moody’s Investors Service, US Municipal Bond Defaults and Recoveries, 1970-2022.

Chart is for illustrative purposes only.

Average annual total returns (%)

5 years ended July 31, 2023

Source: Morningstar Direct, July 31, 2023.

*Taxable-equivalent return. This is the return that is required on a taxable investment to make it equal to the return on a tax-exempt investment. Assumes 40.8% tax bracket (37% federal tax bracket + 3.8% Medicare tax).

Chart is for illustrative purposes only.

Fixed income asset classes are represented by the following indices: High yield municipal – Bloomberg High-Yield Municipal Bond Index; Investment grade (IG) municipal – Bloomberg Municipal Bond Index; US corporate high yield – Bloomberg US Corporate High-Yield Index; US corporate investment grade – Bloomberg US Corporate Bond Index; US Treasury bills – Bloomberg US Treasury Bills Index; US ABS – Bloomberg Asset-Backed Securities (ABS) Index; Eurodollar – Bloomberg Eurodollar Index; Taxable municipal – Bloomberg Taxable Municipal Bond Index; US Agency – Bloomberg US Agency Index; US Aggregate Bond – Bloomberg US Aggregate Index; US Treasurys – Bloomberg US Treasury Index; US MBS – Bloomberg US Mortgage-Backed Securities (MBS) Index.

What this means for investors

We continue to advocate that investors add to municipal allocations to take advantage of the higher-yielding environment we have seen in the municipal market.

In our view, low municipal default rates continue to demonstrate the inherent credit strength of the asset class. Over the past five years, municipals have outperformed other fixed income asset classes, with lower inherent risk. Based on our analysis, the municipal below-investment-grade, or high yield, category is the strongest-performing asset class in fixed income, and has done so with lower default risk.


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