Why Muni Floating-Rate Notes May Be Attractive Now

Boston - Even though interest rates have leveled off a bit in recent months, we continue to believe that municipal floating-rate notes are offering relatively attractive yields with some protection against volatile equity and fixed-income markets.

Muni floating-rate notes -- an often-overlooked part of the market -- may make sense for investors looking to take advantage of rising short term interest rates and a flattening yield curve. This is the case today because short-term rates have risen significantly since the Fed began its tightening campaign in December 2015. In other words, investors can stay on the short end of the curve (2 years or less) and still get much of the yield offered at the longer end of the curve, but with less duration risk.

What are muni floating-rate notes?

Muni floating-rate notes can offer attractive income and a way to potentially hedge against short-term interest-rate risk.

As short-term rates rise, investors may potentially realize additional tax-advantaged income. While fixed-rate bonds could lose value when short rates rise, floating-rate instruments may help protect against rising rates because their duration is effectively zero.

Like bank loans (also called leveraged loans), muni floating-rate notes have coupons that float, or reset, at periodic intervals. The coupons of muni floating-rate notes are tethered to short-term rates such as the weekly Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Index 1 or London Interbank Offered Rate (LIBOR). Both SIFMA and 1-month LIBOR have been moving higher lately (see the figure below), and could continue to rise if the Federal Reserve continues to hike its key short-term rate.

Blog Image Sifma Libor Jan 30

Fed and rates in focus

Muni floating-rate notes typically pay yields that are based on SIFMA or a percentage of LIBOR plus a credit spread. Each coupon floats, or resets, at periodic intervals based on the movement of SIFMA or LIBOR. In that way, they are similar to bank loans.