Recommendation: You should consider long-end municipal debt

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While munis are no longer cheap on an absolute basis, they remain relatively attractive, especially long-end muni bonds. Plus, the sector looks compelling given improving issuer credit conditions and higher tax revenues.

Muni bonds

Market Realist – The graph above shows the year-to-date, or YTD, returns offered by various segments of the fixed income market, as measured by Barclays indices.

U.S. corporate high yield bonds (HYG)(JNK) have given returns of 3.7% YTD. U.S. Treasuries (TLT) have given YTD returns of 4.7%, while U.S. aggregate (AGG)(BND) bonds have given 5.6% YTD. Treasury inflation-protected securities (TIP) have given returns of 5.5% YTD. Municipal bonds (MUB) have outperformed all other segments, with returns of 8.9% YTD.

Municipal bonds have given positive returns in nine straight months up to September 2014.

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You can chalk up one of the primary reasons for the positive movements of muni bonds to the supply and demand mismatch. In September, $22 billion worth of muni bonds were issued. This is 20% fewer than the ten-year average and 10% fewer than the five-year average. The demand for the asset class is high, on the other hand, due to the flight to quality resulting from the rising geopolitical turmoil. Another factor benefiting the asset class is the low-rate, high-tax environment. Since muni bonds give tax benefits to investors and also offer better returns than most other fixed investment asset classes, they could make for a good investment opportunity.

Read on to the next part of this series to learn why you should overweight mortgage-backed securities and keep your portfolios flexible.

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