In last week’s blog post, Curve Appeal!, I reviewed the strategy to diversify fixed income investments along the short-, medium- and long-term parts of the yield curve. We saw that over the past few years, the shorter parts of the yield curve have outperformed the longer parts. That blog post focused on the taxable universe of fixed income investments, but the principle also applies to the tax-free universe, as well.
The tax-free bond universe is made up mostly from state and local governments and also include special authorities or school districts. The tax code in some states and the Federal government give these issuers special privileges to issue bonds on a tax-free basis that the markets price at a lower interest rate than if they were taxable.
As seen from the table below, the past 5 years have not been kind to the municipal bond market. The top part of the table shows that longer term municipal bonds have barely posted positive returns with the largest municipal bond ETFs ($39 billion Vanguard Tax-Exempt Bond Index Fund ETF, VTEB and $39 billion iShares National Muni Bond, MUB) both producing 0.8% annualized return over this 5-year horizon. Not surprisingly, consistent with the taxable universe, the shorter parts of the municipal yield curve shown by iShares Short-Term National Muni Bond (SUB) and Fidelity® Massachusetts Municipal Money Market Fund (FMSXX) have outperformed (just barely!) the longer parts over most time frames and overall.
Obviously, these past results are no comfort to investors looking for a long term conservative investment strategy to provide growth and income since it has produced little of either! Fortunately, over the past few years most of the return has come from the tax-free income component instead of the price component. This will benefit those investors most interested in generating income to spend, even though it has not been large.
Investors cannot generate more return without taking more risk. The ideal situation is to have a split strategy with a conservative “bucket” to satisfy the investor’s desire for safety and other riskier “buckets” to meet growth and aspirational desires. In that way the investor is not forfeiting all growth prospects at the expense of lower returning conservative strategies. D&A always works with its clients to ensure that they have the appropriate strategy mix.