The municipal bond market is inefficient, fractured and constantly in flux, and active muni investors are much better equipped to navigate it than are passive ones—an advantage that we believe can improve outcomes.
In fact, we found that—historically—an astonishing 98% of active muni strategies have meaningfully outperformed passive approaches over rolling three-year periods, and 89% have outperformed passive strategies over two-year periods. Further, active strategies delivered better upside and downside capture through some very volatile markets. Here’s why.
Active strategies can proactively align with market shifts and dislocations, while passive approaches cannot. By continually adjusting a portfolio, active investors can flex with current conditions, better manage risks and capture opportunities as they arise.
As we see it, much of the active muni manager’s edge comes from three strategies: yield-curve and duration positioning, municipal credit selection, and dynamic sector rotation, especially into Treasuries.
Yield-Curve Positioning: Responding to Shifts and Shapes
The shape and slope of the yield curve frequently change in response to economic growth expectations, inflation expectations, central-bank policies and more.
Active managers may choose to own different combinations of maturities along the municipal yield curve to take advantage not only of relative yield levels but also of expectations for changes in the shape of the yield curve down the road. Whether a barbell, ladder or concentrated position, there’s no “all weather” maturity structure, because different environments call for different approaches.
For example, a barbell maturity structure invests in short- and longer-term muni bonds, while minimizing exposure to the middle of the curve. A barbell structure fared well in 2024 as the yield curve shifted (Display, left), providing higher returns relative to concentrated and ladder approaches (Display, right).
With today’s curve reverting toward a more normal shape, we think a modified barbell structure that includes select intermediate bonds can help investors capture attractive yields while enjoying a potential price boost.
Concentrated and laddered maturity structures are good fits for other circumstances. A concentrated, or bullet, structure invests in a very narrow maturity range. By contrast, a laddered portfolio spreads bond holdings evenly across maturities.
Credit Selection: Leaning In (or Out) as Needed
Income is a key contributor to muni returns, and active strategies can take advantage of a broad muni universe to help maximize it. One way to boost income is by strategically adding municipal credit.
Muni credit, which includes non-investment-grade, BBB-rated and A-rated issues, historically has offered significantly more yield than the highest-quality bonds (Display, left). We believe muni credit will continue to offer attractive income, backed by strong issuer fundamentals. For instance, we’re seeing consistently healthy balance sheets (Display right), which is a key reason why municipal bond defaults in general are rare.
While credit spreads have tightened, we currently see opportunities in select sectors such as prepay energy, affordable housing and utility districts. The credit universe isn’t static, so we think investors should stay selective when leaning in.
Dynamic Sector Rotation: Active’s Incremental Leg Up
For investors subject to high tax rates, municipal bonds have generally made sense over the years, as they do today. But market technicals such as supply and demand can make relative after-tax yields highly variable over time. In fact, tax-advantaged muni yields have occasionally been lower than after-tax yields for Treasuries (Display).
As we see it, this ongoing dynamic presents opportunities for nimble investors. For example, when spreads suggest that munis are becoming too expensive relative to Treasuries, a small opportunistic position in Treasuries may be appropriate. Conversely, rotating away from Treasuries and back into high-grade municipals seems prudent when spreads widen and munis are again considered fairly valued or relatively cheap.
From mapping the yield curve to thoughtful sector and security selection, small ongoing adjustments can have a big impact on a municipal bond portfolio. As we see it, capturing higher after-tax yields, managing volatility and having the dry powder to lean back into munis when needed can all lead to better outcomes. That’s why we believe staying active matters and flexibility pays off in the end.
The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.
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