The adjustment in the muni market and the move higher in yields have been abrupt. The bad news: Q1 2022 was the worst-performing first quarter on record. The good news: taxable equivalent yields (TEY) have jumped by as high as 257 bps in some areas of the curve, providing a significant increase in tax-free income to clients’ municipal portfolios. The majority of street analysts tend to focus on total return in almost all asset classes, and we agree that this is how most asset classes should be based. However, for SMA investors in municipals, we believe the primary focus should be on the level of tax-exempt income generated by portfolios. Or simply, what is the best after-tax return vs. total return?
“However, for SMA investors in municipals, we believe the primary focus should be on the level of tax-exempt income generated by portfolios. Or simply, what is the best after-tax return vs. total return?”
As detailed in the graphs above, municipal yields adjusted higher by 104 to 152 bps across the curve in Q1 2022, with an even more significant jump in taxable equivalent yields. For example, the 2-year spot moved higher by 152 bps, while the taxable equivalent jump was 257 bps for the period. As a result, the MMD 2-year now reflects a taxable equivalent yield of 2.97%-nearly 3% taxable equivalent for a short-term AAA-rated municipal.
We believe that the muni market will continue to see volatility for the remainder of the year. The threat of price volatility could keep many investors on the sidelines. However, we view the move as a buying opportunity for clients with a long-term view, as we can now offer yields we have not seen consistently in many years. These higher yields translate to a relatively attractive stream of tax-exempt income in an asset class that has historically offered stability, low default rates, and low correlation riskier assets.
Disclosures:
Past performance is not indicative of future results. Investing involves risk including the potential loss of principal. This material is not financial advice, or an offer to sell any product. This is not a recommendation to buy or sell a particular security. It should not be assumed that the investment recommendations or decisions we make in the future will be profitable, or will equal the investment performance of the securities discussed herein.
APA is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about the advisor including its investment strategies and objectives can be obtained by visiting www.assetpreservationadvisors.com. A complete description of APA’s fee schedule can be found in Part 2 of its FORM-ADV which is available at www.assetpreservationadvisors.com or by calling (404) 261-1333.
Charts presented above are based off the highest individual federal tax bracket.
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