With Municipal Bonds, Make the California Call
Declining yields on cash instruments are prompting income-hungry clients, particularly those in older age demographics, to query advisors about alternatives without taking on more risk. Enter municipal bonds.
The widely followed ICE AMT-Free US National Municipal Index sports a trailing 12-month yield of 3.18% -- not eye-catching, but decent when considering the index’s duration of 6.57 years and the fact that roughly 96% of the bonds in the gauge are rated AAA, AA or A. In other words, clients aren’t taking on significant credit risk to tap the income and tax benefits offered by municipal bonds, broadly speaking.
Something else to ponder as it relates to municipal bonds is that this arguably increasingly fertile territory for active management. Yes, many of the most popular ETFs and index funds in this category are homes to thousands of bonds and feature low expense ratios, but the constraints of indexes diminish the ability of these products to be tactical.
Another way of looking at that is the opportunity set offered by municipal bonds isn’t linear across states and municipalities. It can literally pay to focus on some jurisdictions over others with California standing as a prime example.
Make a Golden Call With California Munis
As is widely documented, California is the world’s fourth-largest economy. When adjusted for cost of living, it’s ranked 11th, which is still impressive. The point is the Golden State has the economic prowess to support its hefty municipal bond obligations.
“Healthy financial reserves and substantial internally borrowable resources/special funds (current $90B; 5Y avg $98B) support strong liquidity,” according to BlackRock.
Another point in favor in California munis and one that might not be realized by clients that don’t live there is that due to the state’s status as home to scores of S&P 500 member firms, revenue there benefits when stock prices rise. You know, stock options for the folks in Silicon Valley.
Image: BlackRock
That scenario is likely to be further boosted with a wave of ballyhooed initial public offerings from artificial intelligence (AI) giants such as Antrhopic and OpenAI. Elon Musk’s SpaceX is testing the IPO waters before those companies and while it’s no longer based in the Golden State, it has a large employee count there. Plenty of those workers are soon to become new mutli-millionaires. Good for them and good for Sacramento coffers.
Areas of Emphasis with California Munis
California municipal bonds are attractive, particularly for affluent clients living in that state, because of the federal and state tax breaks. Those are likely among the reasons why retail demand for Golden State munis is soaring, depressing credit spreads in the process.
“This means investors are not getting paid for the risk they are taking on by investing in general obligation bonds issued by the state. Instead, the BlackRock Municipal Credit team prefers revenue bonds over tax-backed bonds in the state,” adds the asset manager.
That also spells opportunity for advisors. Some clients may be buying individual California municipal bonds without knowing where to look to find the best opportunities or they may be missing out on the benefits of broad actively managed funds with heavy or dedicated exposure to California.
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