Investment Ideas—Is the Muni Comeback Still in the Making?

Making the case for municipal bonds today with Stephen Dover, Head of Franklin Templeton Institute.

We think current conditions provide opportunities in municipal bonds that fit well within a broad portfolio allocation.

For our continuing Investment Ideas series, we discussed the complexity of investing in the US municipal bond market with two of our leading professionals in this space: Jennifer Johnston, Director of Municipal Bond Research at Franklin Templeton Fixed Income, and Barbara Ferguson, Portfolio Manager for Municipal Bond Strategies at Western Asset Management.

Here are my key takeaways from the discussion:

  • Municipal bonds have attractive, unique characteristics to consider today.
    • Relative to other fixed income asset classes, municipal bonds offer higher average credit quality with lower average default rates.
    • Supply and demand drive opportunities, and there is currently a shortage of municipal bond supply. On the supply side, issuance of new bonds has been lower as state and local budgets are in better shape following the pandemic and municipalities need less financing capital. In contrast, issuance of US Treasuries and corporate debt has increased dramatically. Along with a smaller supply of munis, demand is rising.
    • Municipal bonds tend to trade less efficiently than other fixed income instruments. We believe professional managers are best equipped to identify and take advantage of investment opportunities stemming from these market inefficiencies.
  • Specific to cash or money market holdings, municipal bonds offer attractive opportunities.
    • Our panel cautioned that an investor could miss opportunities in municipal bonds by waiting to invest. Currently, the municipal bond yield curve is inverted. As it corrects, there will be a race to invest, but many opportunities will be gone by then. We believe investors should consider “putting a toe in the water” with the addition of munis to their portfolios.
    • Reserves built up in state and local government rainy day funds during the pandemic (due to greater Federal grant money and lower expenditures on government services) should help them weather economic downturns or even a recession.
    • Historically, municipal bonds have offered above-average performance and tend to recover following periods of poor performance.1
    • In 2025, current US tax rates are set to expire, which would cause taxes to revert to a higher level if Congress does not intervene. Should this happen, municipal bond holdings could become even more attractive due to their tax-free income streams.