For Muni Investors, COVID-19 Provides Lessons in Liquidity

Over the years, individual investors have flocked to municipal bonds to meet safety, income and after-tax return goals. The recent coronavirus-driven liquidity crunch underscores that investors should also think carefully about how they gain exposure to the asset class.

Municipal Bonds Still Look Compelling

There’s no question that munis continue to play their tried-and-true role of tax-advantaged anchor to windward. Despite recent short-term turmoil, the municipal market’s profile—as measured by historical risk, return, risk-adjusted return (or Sharpe ratio) and diversification against stock-market downturns—remains attractive (Display 1).

Not only have municipal bonds provided a higher historical risk-adjusted return than stocks even before taxes, but they have also zigged when equity markets zagged—serving as a buffer when it’s needed most. And most munis offer preferential tax treatment.

Good financial health coming into the pandemic bodes well for the market’s long-term survival, as does municipals’ characteristic resiliency. Municipal bond defaults have been rare, thanks to factors like reliable revenue streams, the power to raise taxes and cut costs, and provision of essential services. Since 1970, the cumulative default rate for all municipal bonds was just 0.1%.

While yields are likely to remain low for a long time, munis should continue to offer individual investors relative safety and tax-advantaged returns.