Why muni bonds could offer extra yield for long-term investors

Investors who want to lock in income for a long time should take a look at a slice of the municipal market that is often ignored, according to the bond chief at BNY Wealth. Municipal bonds are debt issued by state and local governments and related entities to fund their spending. While the bonds usually pay lower nominal yields than corporate bonds with the same credit rating, they can also be tax exempt for some investors, raising their effective yield. John Flahive, head of fixed income at BNY Wealth, told CNBC that buyers of municipal bonds are overwhelmingly individual retail investors. That group is typically focused on bonds that mature within the next 10 years, a demand pattern which gives this part of the bond market a much different “yield curve” than the Treasury market. “The muni curve is way steeper 10s to 30s, and probably will always be because of this dynamic … retail [investors have] been taught to basically buy ladders out to 10 years,” Flahive said. The steeper yield curve — shorter-term debt yielding less than long-term paper — means that investors can get more income on an annual basis if they are willing to buy and hold long-term bonds. “I still find a lot of opportunities in the long-end of the curve, especially, I’ve been telling our clients, the 15- to 20-year part of the curve is kind of interesting to us,” Flahive added. Locking in higher yields over a long period of time could be particular attractive to investors right now, with the Federal Reserve widely expected to begin cutting interest rates later this month. BNY Wealth expects the Fed to lower its benchmark rate by 75 basis points, or three quarters of a percentage point, by the end of the year, with a larger reduction possible if economic data weakens, Flahive said. A basis point equals 0.01 percentage point. To be sure, there are some risks in the municipal bond market. Flahive said that the reliance on individual investors makes the sector “vulnerable,” and that the spread of between municipal bonds and ultra-safe Treasurys may be too small given the additional credit risks in munis. “Spreads have come way in, almost alarmingly so. … There seems to be not a lot of angst as it relates to credit quality of municipal bonds, and we think that’s a mistake,” Flahive said. Flahive is also the manager of the BNY Mellon Municipal Opportunities Fund (MOTMX) . The fund has a five-star rating from Morningstar, which says its performance has landed in the top quartile for its category in seven of the past 10 years.