Look to Insured Munis for High Quality and Attractive Income

by: , Product Management, New York Life Investments

MacKay Municipal Managers have said that insured municipal bonds are like having a belt with suspenders. What does that mean? Investment grade municipal bonds are already high-quality investments, with historically lower default rates than similarly rated corporate bonds. When you wrap the bonds in insurance it adds an extra layer of protection, so that in the event an issuer files for bankruptcy and can no longer service the debt, the insurance company will step in and pay the coupon and principal. Essentially, there are two entities available to pay back bondholders.

This doesn’t mean insured municipal bonds are safer than Treasuries (the two remaining municipal bond insurers writing new business were most recently rated AA), but what they lack in a top notch rating they make up for in better long-term historical performance and attractive tax-equivalent yield. That yield component will continue to be important now that the Federal Reserve has cut rates and may continue to do so, making the hunt for yield top of mind for investors.

Figure 1 shows how insured municipal bonds have performed compared to Treasuries since the start of 2018. The shaded areas represent time periods that the S&P 500 Index saw significant drawdowns; as expected, during these periods Treasuries outperformed. However, even with four volatile time periods over 19 months, insured municipal bonds still outperformed Treasuries by a cumulative 300bps, and with generally less drawdown (as shown in Figure 2).

Figure 1: Cumulative returns of insured municipal bonds vs. Treasuries

Source: Morningstar, 1/1/18-8/9/19 Past performance is no guarantee of future results. You cannot make an investment in an index. SPX: S&P 500 TR USD. Insured munis: BBgBarc Municipal Insured TR USD. Treasuries: BBgBarc US Treasury TR USD.

Figure 2: Daily drawdown of insured municipal bonds vs. Treasuries


Source: Morningstar, 1/1/18-8/9/19 Past performance is no guarantee of future results. You cannot make an investment in an index. Insured munis: BBgBarc Municipal Insured TR USD. Treasuries: BBgBarc US Treasury TR USD.

Also to keep in mind is that municipal bonds have historically been less sensitive to changes in interest rates than Treasuries. We recently saw how this played out as the Fed cut rates by 25bps: the yield on Treasuries of the same maturity dropped almost twice as much as insured municipal bonds, which Figure 3 illustrates. As a result, insured munis now generate even more tax-equivalent yield relative to Treasuries. Prior to recent market events which saw US Treasury yields decline rather dramatically, an investor earned 75% more yield through insured munis than Treasuries on a tax-equivalent basis. As of 8/7 that incremental yield increased to 89% given the lower rate sensitivity of insured munis (see Figure 4).

Figure 3: Insured municipal bond tax-equivalent yield vs. Treasury yields before and after the Fed’s announcement to cut rates

Source: Barclays, 8/9/19. Past performance is no guarantee of future results. You cannot make an investment in an index. Insured munis: BBgBarc Municipal Insured TR USD. Tax-equivalent yield = municipal bond yield/(1-tax rate). The tax rate equals 37% (highest Federal marginal tax bracket) plus 3.8% (Medicare surtax).

Figure 4: The incremental tax-equivalent yield earned on insured munis over Treasuries rose from 75% to 89% as a result of the recent rate drop

Source: Barclays, 8/9/19. Past performance is no guarantee of future results. You cannot make an investment in an index. Insured munis: BBgBarc Municipal Insured TR USD. Tax-equivalent yield = municipal bond yield/(1-tax rate). The tax rate equals 37% (highest Federal marginal tax bracket) plus 3.8% (Medicare surtax).

Given the current environment of lower rates and high equity valuations, investors may want to consider a high-quality bond exposure with a competitive yield, lower volatility than Treasuries and total return potential such as insured municipal bonds. One way to access this segment of the muni market is with the IQ MacKay Insured Municipal ETF (MMIN)*.

*Click on the fund name for the most current fund page, which includes, the prospectus, investment objectives, performance, risk, and other important information. Returns represent past performance which is no guarantee of future results. Current performance may be lower or higher. Investment return and principal value will fluctuate, and shares, when redeemed, may be worth more or less than their original cost. Visit nylinvestments.com/etfs and nylinvestments.com/funds and for the most recent month-end performance.

Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value.

This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

A drawdown is a peak-to-trough decline during a specific period for an investment, trading account, or fund.

The Federal Open Market Committee (FOMC) is the monetary policymaking body of the Federal Reserve System.

The S&P 500 Index is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE, NASDAQ, or the CBOE BZX Exchange.

The tax-equivalent yield is the pretax yield that a taxable bond needs to possess for its yield to be equal to that of a tax-free municipal bond.

“New York Life Investments” is both a service mark, and the common trade name, of the investment advisors affiliated with New York Life Insurance Company. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC and serves as the advisor to the IndexIQ ETFs. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.
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Maria Rahni, CFA

Product Management, New York Life Investments

Maria Rahni is a Senior Associate in the Product Management group at New York Life Investments, covering multiple asset classes for MainStay and IndexIQ…

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