Investors can nab extra yield with this under-the-radar municipal bond play, says Nuveen

There’s a small part of the municipal bond market that could provide a big opportunity to investors, according to Nuveen. Charter schools are just a fraction of the education muni bond landscape, but increasing demand for the schools should result in strong supply, said Dan Close, the firm’s head of municipals and lead portfolio manager for high-yield municipal strategies. On top of that, the bonds can return a tax-equivalent yield of nearly 8% for those in the highest tax bracket, he said. “We’ve just seen a growth and diversification among what we could choose from,” he said. The Nuveen High Yield Municipal Bond Fund , which Close manages, has about 9% of its assets in charter school muni bonds. NHMAX 1Y mountain Nuveen High Yield Municipal Bond Fund Charter school bonds fund construction, renovation or the purchase of school facilities. The interest is exempt from federal tax and, in some cases, the bonds are free of state taxes as well. While charter schools are nothing new, there’s been an acceleration in demand thanks to the pandemic and legislation in states that supports school choice, Close pointed out. There are currently about 8,000 charter schools in the United States serving 3.7 million students, according to the National Alliance for Public Charter Schools . The schools gained more than 300,000 students since the 2019-2020 school year, although they still account for less than 10% of the overall public student body, according to a December report by the organization. At the same time, traditional K-12 public schools lost more than 1.5 million students, the report found. Within the $580 billion K-12 education muni bond sector, charter schools make up about $33 billion, Close said. Issuance declined in 2023 and 2024 due to rising interest rates and he’s predicting that will turn around — with about $4 billion to $5 billion in issuance coming in 2025. “We’re seeing more paper coming out, and this paper — because charter schools can’t levy their own dedicated taxes — have a higher risk profile, but they also have a much higher yield, which we think provides a very unique opportunity set,” he said. While traditional K-12 education munis are considered investment grade, mainly with ratings of AAA and AA, most charter school munis are not rated. That’s because they are often early in their operating history, which makes it likely they would be rated deep below the investment grade category if they pursued a rating agency rating, Close explained. Therefore, it isn’t worth paying for the rating when they would get little to no benefit, he said. That said, some 15% are investment grade, while 17% are below investment grade. Issues that are rated below BBB by Standard & Poor’s are considered high yield. “As investors, we see value in investing in these early-stage schools, as our investment thesis is to purchase the bonds early in a school’s life cycle so that our bonds experience credit improvement as the school builds its facility and grows enrollment,” he said. Investors are being paid to take that risk. Traditional K-12 bonds pay about 3.5%, while charter school bonds yield around 5% — a 150 basis point difference, Close said. Add the advantages of tax breaks, and that yield is closer to 8%, he said. Nuveen’s criteria That said, investors should do their homework. Nuveen has four charter school analysts to identify schools they believe will be successful over time. They consider factors such as the location, which should be a demographically supportive area with limited competition, Close said. The schools should also have solid academic performance and a curriculum that sets it apart from other local public schools, he added. There should also be good fiscal management and strong legal and security provisions, including a mortgage, he said. Among the names the firm holds in its High Yield Municipal Bond Fund are The Academy Charter School in Hempstead, New York; Norton Science and Language Academy in San Bernardino, California; and Community of Peace Academy in St. Paul, Minnesota.