US Taxable Municipal Bonds: Beyond the Basics

US retail investors have long dominated the US municipal bond market, but over the last decade institutional interest in the sector has soared, particularly outside the US. So far, these non-traditional investors have been rewarded. Over the last 10 years, municipal bonds have performed well (see Figure 1). Consequently, the taxable municipal sector’s 2.6% annualized total return for the period outperformed the 2.4% return on US corporate investment-grade bonds, a staple in most institutional portfolios. But strong returns are just one of many reasons that non-traditional investors have ventured into the asset class. Taxable municipal bonds are also garnering interest due to their high-quality ratings, inefficient pricing, low correlations, diversification to other asset classes and potential for liability matching.

New Interest in an Old Sector
Institutional interest in U.S. municipal bonds was whetted in 2009, when the Obama Administration created the Build America Bond (BAB) program to stimulate an economic recovery from the Great Recession. At the time, many states and cities were having difficulty tapping the traditional, tax-exempt municipal bond market to fund capital projects. As a solution, BABs subsidized the interest cost on taxable municipal bonds to make them affordable to issuers and broaden their potential investor base. Over the two years the program was in effect, issuance of taxable municipal bonds surged from $24 billion in 2008 to $85 billion in 2009 and $152 billion in 2010.1 Over the past decade the market continued to grow, and today stands at approximately $800 billion².