The Dismal Failure of Actively Managed Municipal Bond Funds

New research documents the abject failure of the vast majority of municipal bond funds to outperform a passive benchmark.

Academic research, as presented in my book co-authored with Andrew Berkin, The Incredible Shrinking Alpha, and supported by the annual SPIVA scorecards, shows that for both common stock and taxable bond investors, a passive strategy of merely tracking a benchmark index generally outperforms active strategies after accounting for portfolio management fees. Joshua Gurwitz, David Smith and Gerhard Van de Venter contribute to the literature on the performance of active management with their study, “Municipal Bond Mutual Fund Performance and Active Share,” published in the June 2021 issue of The Journal of Investing.

Gurwitz, Smith and Van de Venter evaluated the performance of actively managed U.S. open-end municipal bond mutual funds between 1999 and April 2020 using both benchmark-adjusted returns (such as the Bloomberg Barclays Municipal Bond Total Return Index) and a four-factor pricing model. The four factors were: (1) the return on the Bloomberg Barclays Municipal Bond Total Return Index less the return on the one-month T-bill, (2) the excess return of each open-ended mutual fund’s (OEMF’s) benchmark less the return on the one-month T-bill, (3) the yield spread between 10-year and three-month constant maturity Treasury securities (term spread), and (4) the difference in average yield between Aaa and Baa corporate bonds (credit spread). The corporate bond spread was used in place of the municipal bond spread for data availability reasons.

The authors began by noting that more than 99% of the $815 billion in assets held in U.S. municipal bond mutual funds at year-end 2019 were actively managed – most municipal bond portfolio managers selected individual securities issued by state and local governments; made geographical, quality or duration bets; or timed movements into and out of cash in an attempt to outperform benchmark indexes. Their final dataset contained 512 U.S. municipal bond OEMFs of which 199 “national” funds were classified as high-yield, short-term, intermediate-term and long-term classifications. Geography was the dominant feature in the remainder of the funds, focused on a single-state issuer.