Yet nothing has shaken our belief that despite the legitimate revenue deficit as part of the legal process in Washington and the market’s response to the political position, the municipal fixed income sector remains sound. Moreover, we emphasize that the municipal market now represents an opportunity for taxable investors in many brokerage accounts.
Here are some reasons for our optimism:
- The default rate for investment-grade municipal bonds is historically very low. Although Vanguard believes that the expansion of municipal bond credit spreads is related to investors’ feelings in implementing the federal government’s assistance in the “Phase Four” stimulus package considered by Congress, these concerns focus on rating downgrades rather than solvency. The default levels of municipal bonds were low, and we see no reason to increase those rates significantly, as a large portion of the municipal market is provided by essential services such as state government, public transport and hospitals.
- Municipal bond rulebooks are unlikely to change. States are not allowed to file for bankruptcy under federal law, and it will take a congressional action and possibly a U.S. Supreme Court ruling to change it. Despite some advice in Washington, there will be little political appetite for allowing state bankruptcy, where judges will have to choose between creditors, pensioners, state employees and important services. Political debate will actually put no limits on any federal aid that can eventually be sent to the states.
- The move by the Federal Reserve will help. The Fed’s announcement earlier this month of a municipal loan facility, which would offer up to এবং 500 billion in two-year loans to states and specific counties and cities, reaffirms our view that the risk of default in investment-grade municipal bonds is very low.
In addition to these reasons for optimism, investors in our tax-free bond funds can find comfort in our time-tested process and structure.
- Vanguard’s tax-free bond funds focus heavily on diversified and high-quality securities. Our funds invest across a wide range of issuers and sectors, making them less risky for significant changes in any single segment of the municipal bond market. The municipal market brings a variety of bonds, including different mill structures, revenue flows and terms. Our highly experienced team of more than 40 municipal credit analysts, traders and portfolio managers verify the risk factors present in our bonds, so that our clients’ assets are managed prudently.
Investors should keep this in mind The response to short-term volatility can be detrimental to the results of long-term investments. By selling when the market is under pressure or facing volatility, investors run the risk of destroying long-term value by losing the opportunity to participate in market recovery. For example, the broad-market S&P National AMT-Free Municipal Bond Index fell nearly 11% during the recent market volatility (total returns from March 10 to March 20, 2020). But since then, the index has recovered significantly, with a total return of 7.7% (March 23 to April 22, 2020). Investors who sold below or near will miss the next partial recovery, which also includes tax-free income generated by municipal bonds. (Past performance does not guarantee future income.)
Currently, the yield curve for AAA-rated municipal bonds is much higher than for U.S. Treasury securities and, for many end clients, represents a tax-compliant yield comparable to other investment-grade taxable bonds. Therefore, the opportunity for favorable tax-free income remains.
In short, iNvestors should focus on their long-term investment plans and tone the noise. Short-term volatility and political joking for additional policy support could be a potential dilemma for investors. Vanguard encourages investors to stay focused on things they can control, such as creating clear investment goals, adhering to strategic asset allocations, reducing costs, and maintaining a long-term outlook.
All investments are at risk, including the potential loss of the original investment.
Diversity does not guarantee gain or protect from loss.
Bond funds are subject to the risk that an issuer will fail to pay on time and the price of the bond will fall because of an increase in interest rates or a negative perception of the issuer’s ability to pay.
High-yield bonds typically have medium- and low-grade credit-quality ratings and are therefore subject to higher levels of credit risk than bonds with higher credit-quality ratings.
Although income from a municipal bond fund is usually exempt from federal income taxation, you can pay tax on any capital gains earned through the trading of the fund or the redemption of your own shares. For some investors, a portion of the fund’s income may be subject to state and local taxes as well as federal alternative minimum taxes.