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Published: May 26, 2020 8 min read

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Chris Gash for Money

If you’re one of the many investors in the $3.9 trillion municipal-bond market, the coronavirus may have you asking: are my safe-haven municipal bonds really that safe?

Municipal bonds –– bonds issued by governments and agencies, often to finance projects like airports, schools and infrastructure –– have long been considered a low-risk source of retirement income. These state and local bonds have a historically low chance of defaulting, and most of them are tax-free so, unlike corporate bonds, investors don’t have to pay taxes on the interest. But the coronavirus has shaken confidence in the safety of these bonds, as investors wonder if cash-strapped governments can continue to pay the interest on their debt.

As the coronavirus worsened in March, investors pulled their money from municipal mutual funds. Over the week that ended March 18, net outflows from municipal bond funds hit $12.2, billion, the largest retreat in a week since 1992, according to data from Refinitiv Lipper. Even though the Federal Reserve stepped in to lend a hand to state and local governments, first by expanding its asset purchase program to include short-term municipal bonds in March, there are worries about whether municipal bonds are worth the perceived risk.

Chasing yield

Municipal bond yields jumped when the heavy outflows in March from municipal funds put pressure on the market and caused prices to sharply decline (bond prices move inversely to their yields).

Since then, yields have come down, but it's taking high-yield prices a bit longer to recover. The iShares National Muni Bond ETF, which includes investment-grade bonds, is currently yielding 1.76% while the Nuveen High Yield Municipal Bond Fund is yielding 5.35%.

While it can be tempting to chase relatively high yields, don’t buy indiscriminately. If you pay attention to the different types of municipal bonds and how you’re investing in them, they can still be a good option for retirement income, experts say.

“Investing in muni bonds isn’t as easy as buying whatever muni and then falling asleep,” says Nicholos Venditti, portfolio manager for Thornburg Investment Management. “Investing in munis today –– and probably, it should have been yesterday or six or eight weeks ago –– is going to require more work.”

Most states are required to balance their budgets, so they don’t tend to see budget deficits like the federal government does. But they rely on income like tax revenues, which they won’t see for a couple more months because the tax filing deadlines have been pushed back in most states. The pandemic also raised the cost of governing, and state and local governments have had to tap their rainy day funds.

The main concern in the municipal market is around high-yield bonds. While these bonds may offer higher income for investors, they also come with a lot more risk. The high-yield market tends to see a lot more speculative deals, which will face an even more uphill climb with the impact of coronavirus, Venditti said. The bond-financed American Dream Mall in New Jersey, for example, seemed like a tough sell even before the pandemic, as it was relying on attracting a lot of visitors at a time when brick-and-mortar stores are battling online shopping options. Raking in those mall-goers now, while shoppers are facing stay-at-home orders, seems almost impossible, Venditti adds.

It’s important to consider bond ratings as well, because rating agencies analyze offerings to determine how likely the bonds are to default. High-yield bonds are typically unrated or have ratings that are below investment grade (below Baa3 on Moody’s scale and below BBB- on Standard & Poor's and Fitch’s scales).

There may also be risk in sectors that could be especially pained by the coronavirus, like airports and retirement communities. The task for investors in the current market is less picking the right sector and more picking the right credit within that sector, Venditti says. There will be a difference in credit quality on an issuer-by-issuer basis.

Choosing individual bonds

If you’re investing in individual securities, as opposed to mutual funds or ETFs, you have the flexibility of choosing one issuer over another. Venditti, who works at an investment management company where the municipal bond funds are only invested in individual securities, says he does an analysis to find the best securities in troubled sectors. When looking at airport bonds, for example, he’d be more likely to choose a bond from the Dallas/Fort Worth International Airport than Orlando International Airport. People fly through Dallas on their way to other airports –– it’s not a destination spot as much as Orlando, he explains, so Dallas’ airport is likely to recover faster than Orlando’s.

It’s also important to look at the area of the country that you’re buying bonds from, says Jay Sommariva, partner and director of fixed income at Fort Pitt Capital Group. Some states are more affected by the pandemic than other parts of the country and may not be able to raise taxes as much.

Investing in individual municipal securities allows you to pick a specific maturity date –– the day when your principal will be returned to you. You can pick a target date of when you know you might need that money.

If you're in your mid-50s and you plan on retiring in your mid-60s and moving down south, it’s good to invest in a bond maturing in 10 years, Sommariva says.

Investing in mutual funds and ETFs

Compared to individual bonds, buying municipal bonds as part of a mutual fund or ETF provides relative safety because it lowers the impact of a default, says Mike Piershale, ChFC, president of Piershale Financial Group. If you buy bonds in a fund of 500 and one defaults, you’d lose 1/500th of your money.

Funds also have managers whose job is to watch that fund for 40 to 50 hours a week, he adds.

“If he even smells trouble in one of those bonds, he’s going to know it six months before the rest of us have a clue and he’s going to sell that one and buy another one,” Piershale says of fund managers.

The large municipal-bond ETFs are broadly diversified with varying geographical exposure and multiple credit sectors, says Patrick Luby, a senior municipal strategist with CreditSights. What's more, funds are liquid, ensuring that you can sell when you want to.

Just keep in mind that since you can't hold a fund until maturity, you could lose money if it performs badly and you decide to liquidate. However, you won't lose money on an individual bond if you hold it until maturity, because you'll get back your principal (unless the issuer defaults).

“No matter what the market is doing you can always get out of the ETF,” Luby said of large and liquid funds. “You might not like the price, but you can always get out.”

While municipal bonds may continue to struggle as state and local governments seek federal aid, carefully investing in these assets may keep your retirement income strategy on track.

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