Looking for a Source of Potential Diversification? | American Funds

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Sustainable Income | munis | july 2015
Looking for a Source of Potential Diversification?

Beyond Tax-Advantaged Income, Munis May Add a Measure of Stability to Stock-Heavy Portfolios

“It is crucial to develop a deep understanding of what you are investing in. Many municipal bonds will offer solid and reliable returns, while some could be downgraded or even default. This is a true credit market, so using research to build well-diversified portfolios makes a lot of sense.”

Karl J. Zeile Portfolio Manager 26 years of experience (as of 12/31/16)

Favorable Yields and a Source of Potential Stability for a Wider Investment Mix

Charts show yields for 10-year treasuries and municipal bonds as well as correlations of muni bonds to other asset classes

Sources: Bloomberg Barclays Research, FactSet, Federal Reserve, Capital Group. Correlation is a mathematical concept used to describe how closely changes in the returns of different asset classes mirror each other. The degree of closeness is measured from –1 to +1. A correlation of –1 indicates that the two returns tend to move by equal but opposite amounts. A correlation of +1 indicates that the two assets’ returns tended to move up or down in lockstep. A correlation of zero indicates no relationship between the returns of each asset class. For each asset class, the underlying indexes used in the calculation of correlations are as follows: Bloomberg Barclays Municipal Bond Index (muni bonds); S&P 500 Composite Index (U.S. stocks); Bloomberg Barclays U.S. Government Bond Index (U.S. government bonds); Bloomberg Barclays U.S. High Yield Index (U.S. high yield bonds); and Bloomberg Barclays U.S. Corporate Index (U.S. corporate bonds).

On an after-tax basis, many parts of the muni market have offered relatively attractive yields. Revenue bonds — which are backed by specific revenue streams from various things such as toll roads, water and sewage plants, and airports — typically pay higher yields than general obligation bonds issued by states and local governments. Arguably, revenue bonds are the part of the market where credit research-driven active investors can potentially add most value.

Depending on an investor’s net tax burden, investment-grade (rated BBB/Baa and above) munis have recently offered after-tax yields that are meaningfully higher than those of Treasuries and comparable to yields of similarly rated corporate bonds. The yield advantage of munis compared to corporates has been even more pronounced among below-investment grade (rated BB/Ba and below) bonds.

Relative value is only one reason to consider munis. In addition to offering steady income potential, municipal bond returns have tended to have a low correlation with stock returns over time. In other words, an investment in munis may help smooth out the overall volatility of a portfolio that includes stocks, as well as corporate bonds or Treasuries.

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Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing. 

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not to be comprehensive or to provide advice.