Muni valuation update – still a great value

Its been almost 4 months (June 26 to be precise) since I last posted on municipal bond valuations. I thought this would be a good time to do a quick update on muni valuations. In short, there is still compelling value in municipal bonds for long term investors willing to ride out the fear being priced in to this market.

Since my last post, muni prices are about flat. Below is the 6 month chart of the HYMB ETF which represents high yield longer term munis which is where I focused my discussion last time. It currently yields over 5%.

HYMB chart oct 2013

Now lets look at how munis stack up against taxable treasuries and how it relates to history. As in my last post, I like to focus on real after tax yields. The chart below compares real 20 yr muni yields to after tax real 20 year UST yields. I use a 25% marginal tax rate to compare munis to taxable bonds. To calculate real yields I subtracted the CPI from all bond yields. FRED makes this a cinch to do.

FRED Real Munis vs after tax real 20 yr oct 2013

The spread between 20 year real muni yields and after tax UST yields is as wide as its ever been. Of course, this is due to a perception of credits risk in munis. So, next lets add after tax real yields on BBB grade corporate bonds to the chart for comparison.

FRED real munis vs after tax real 20yr and real BBB oct 2013

The data on BBB yield only goes back to 1996 so we have a narrower view but the data is even more compelling. Munis yield more than 1% more than BBB corporates on a real after tax basis. That’s a hell of a lot of credit risk priced in to munis and I think represents a lot of unwarranted fear.

Lastly there is even more value in leveraged closed end muni funds. As an example. I looked at the historical real yield of one of the oldest and best muni CEFs, KSM. I used the same process as above and subtracted the CPI from the KSM distribution yield. The chart of KSM’s historical real yield is below.

KSM real yield oct 2013

 

Basically, ex the financial crisis, real yields have never been higher for one of the best top performing muni bond funds. This is NOT a recommendation. Muni CEFs use quite a bit of leverage and are very volatile and thus not suitable for very conservative investors.

In summary, munis are offering after tax real yields of just over 3%, and over 6% for levered muni CEFs, which represents the best value offered in the entire bond space.

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One Response to Muni valuation update – still a great value

  1. doug nashif says:

    Thanks for another great article Paul.

    I have been using muni cefs for awhile now and have been enjoying the high monthly dividend payout. Yes, they have dropped in price since I first purchased but have recently added to my positions thanks to your articles and the help of some very experienced FI guys over at the Morningstar forum. Personally I like the 6% tax free monthly payout of muni cefs in spite of the price volatility. I am comfortable with and confident that the managers of those funds are well aware of market conditions and are constantly working to improve their respective portfolios.

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