Show Me the Munis! | American Funds

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2016 Outlook

Sustainable income  |  MUNIS  |  January 2016
Show Me the Munis!

Yields Appear Attractive Given Potential Tax Advantages, but That’s Only Half the Story

“With default rates that are low in historical terms and relatively stable credit fundamentals, municipal bonds are, in my view, generally among the more attractive investment opportunities. Even so, it’s crucial to develop a deep understanding of what you are investing in — bond-by-bond, issuer-by-issuer research can add value.”

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

Attractive Yields Are on Offer, but Research Is Vital — This Is Not Your Father’s Muni Market

Sources: Barclays Research, Bloomberg, Capital Group.
As of December 31, 2015. Muni yields are from Barclays Research, and are before-tax. Ratios, expressed as percentages, of yield-to-worst of Barclays Municipal Bond Index compared to Barclays U.S. Corporate Investment Grade Index, Barclays 10-Year Municipal Bond Index compared to 10-Year U.S. Treasury yields, and Barclays Municipal High Yield Index compared to Barclays Corporate High Yield Index, for the period December 31, 2012, to December 31, 2015.

How attractive are muni bond valuations? Very. With ratios — a measure of the relative “size” of before-tax muni yields compared to similarly rated corporates or Treasuries — high, many investors are taking a closer look at munis. Depending on an investor’s net tax burden, investment-grade (rated BBB/Baa and above) munis have recently offered after-tax yields that are comparable to those of similarly rated corporate bonds, while lower rated munis have consistently offered a substantial yield advantage.

But there’s more to the story. In addition to offering steady income potential, municipal bonds have tended to offer a great source of diversification. For instance, investment-grade (rated BBB/Baa and above) and, to a lesser degree, high-yield (rated BB/Ba and below) munis showed a low correlation to U.S. stocks over the 10-year period ended December 31, 2015. In other words, an investment in munis may help smooth out the overall volatility of stock-heavy portfolios.

Puerto Rico’s recent financial woes have underscored that, when investing in munis, credit research is crucial. Arguably, revenue bonds are the part of the market where research-driven active investors can potentially add the most value. Even better, revenue bonds — which are backed by specific revenue streams from various things such as toll roads and airports — typically offer higher yields than general obligation bonds issued by states and local governments.

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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.