Now that negative yields have become a reality, municipal bonds are more critical than ever for income seeking investors, said Jeff MacDonald, director of fixed income strategies at Fiduciary Trust Company International.
"Munis not only compare favorably to the negative yields now being offered by almost a dozen developed markets, but also against most sovereign bonds in positive territory, especially when viewed on a tax-equivalent basis," said MacDonald.
MacDonald added that for investors in higher tax brackets municipal bonds should be the cornerstone of any portfolio.
MacDonald is encouraged by today's historically low default rates in the muni market despite the anxiety created by Puerto Rico and other fiscally-challenged issuers. He said he sees plenty of opportunities to add high-quality sources of yield potential.
"Muni bond issuers are generally behaving in a more fiscally-disciplined manner and it makes sense to identify the sources of stress," said MacDonald. "It is important to determine whether those headwinds are specific to an individual issuer or represent broader, structural themes influencing the market."
In terms of new issues hitting the market, MacDonald said that he is still seeing a lot of refinancings and supply has been "lower than it has been historically." On the flip side, demand has been very strong with over 40 weeks of positive fund flows coming into the muni market, thereby creating a positive technical backdrop.
MacDonald favors revenue bonds, which are backed by cash flows from a specific entity, as opposed to general obligation (GO) bonds, which are backed by the full faith and credit of a municipality.
"When you look at a lot of the bad headlines in the municipal market, a lot of them are coming from the general obligation level and a lot of that stems from the pension obligation issue which is starting to come home to roost," said MacDonald.