WHAT IS A MUNICIPAL BOND?

Municipal bonds, or "muni" bonds, are debt securities issued by states, municipalities, counties, and other government entities to finance public projects such as infrastructure, schools, and transportation systems. When purchasing a municipal bond, investors are lending money to government entities in exchange for periodic interest payments and the return of principal at maturity.

TYPES OF MUNICIPAL BONDS

General Obligation Bonds

• Backed by the full faith and credit of the issuer and its taxing power.

Revenue Bonds

• Secured by specific revenue sources, such as tolls or utility payments.

KEY FEATURES OF MUNICIPAL BONDS

Tax-Advantaged

Interest earned on most municipal bonds is exempt from federal income tax and, in many cases, from state and local taxes if you reside in the state of issuance.

For example, a high-income resident of California would need to purchase a taxable bond yielding almost double what a municipal bond issued by a California entity yields to achieve the same after-tax yield.

High Quality

Typically, municipal bonds are considered lower-risk investments due to their high credit quality and extremely low historical default rates.

WHY INVEST IN MUNICIPAL BONDS?

1. Capital Preservation

Municipal bonds are some of the safest investments in the bond universe, particularly those issued by entities with strong credit ratings. They offer a relatively low-risk avenue for preserving capital while generating steady income. The default rate of investment-grade municipalities is markedly lower than corporate issuers.

2. Portfolio Diversification

Including municipal bonds in a diversified investment portfolio can reduce overall risk. Their low correlation with equities and other asset classes means that they often perform well in market conditions where other investments might falter.

3. Tax-Exempt Income

For high net worth investors, the tax-exempt status of municipal bond interest can provide significant tax savings, enhancing the effective yield compared to taxable bonds. In today's environment, this feature is particularly attractive relative to taxable bond counterparts, offering nearly 0.5% of excess after-tax yield. Municipal bonds can also help mitigate the risk of increased federal taxation from ongoing US budget deficits.

4. Attractive Yields

Municipal bond absolute yields are attractive relative to recent history with current yields-to-maturity doubling the decade average. Importantly, expected municipal bond returns once again exceed inflation expectations by a healthy margin – meaning munis can play a role in wealth creation rather than just preservation.

WHY USE A KOVITZ SEPARATELY MANAGED ACCOUNT (SMA)?

A Separately Managed Account (SMA) offers a customized approach to investing in municipal bonds that is tailored to meet the specific needs and objectives of high net worth investors. The key benefits include:

1. Customization

SMAs provide the flexibility to customize the bond portfolio to align with your investment goals, risk tolerance, tax considerations, and liquidity needs.

2. Active Management

The municipal bond market continues to grow in complexity, with over 50,000 borrowers and over a million unique securities. With an SMA, your portfolio is actively managed by professional investment managers who can assess the fragmented landscape and make timely adjustments based on market conditions, interest rate changes, and credit developments. This active oversight aims to maximize after-tax returns and minimize risks.

3. Optimal Execution

Kovitz generally acts as a liquidity provider to the municipal bond market. By supplying sellers with liquidity, we are able to extract excess yields on our purchases relative to what would be available if we were to purchase bonds out of broker/dealer inventories. In less liquid markets, like for small quantity “odd-lot” municipal bonds, this price differential can significantly boost returns for bidders.

4. Tax Efficiency

Active management within an SMA can enhance tax-efficiency by focusing on a customized approach to increasing after-tax yields. We employ strategies such as tax-loss harvesting to minimize tax liabilities, optimizing overall after-tax returns, and avoiding issuances from high-tax states, which trade at artificially high prices for out-of-state investors that receive no resident tax benefits.

5. Direct Ownership

SMAs offer investors a level of control that cannot be matched by fund structures. This control becomes particularly valuable during periods of market turbulence. Investors owning bonds outright can ride out the storm with confidence that prices will stabilize and bonds will mature at par, creating natural ongoing liquidity. Through a fund structure, the stressed selling of others can lead to losses being crystalized for all investors in the fund.

CONCLUSION

Municipal bonds offer high net worth investors a compelling combination of tax advantaged income, capital preservation, and portfolio diversification. Utilizing a Kovitz Separately Managed Account further amplifies these advantages through personalized management and tax efficiency, making it an ideal vehicle for investors seeking to optimize their fixed income allocations.

For further information or to explore how a municipal bond SMA can fit into your investment portfolio, please contact a Kovitz financial advisor.

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1 Tax-free muni yield is from the Yield to Worst on the Bloomberg Muni 1-10Yr Blend Index as of 5/31/24.

2 Source: Moody's Investors Service, US Municipal Bond Defaults and Recoveries as of 4/21/22 (latest available data). Municipals are represented by the Bloomberg Municipal Bond Index. Corporates are represented by the Bloomberg Global Aggregate Credit Index.

3 Historical ratings have been adjusted to be consistent with the global rating scale as described in Appendix G. | Source: Moody's Investors Service

4 The High Yield index is the Bloomberg U.S. Corporate High Yield index. Data as of 5/31/24

5 Bloomberg US Intermediate Credit Index. After-tax yield assuming a 40.8% rate. Data as of 5/31/24.

6 Bloomberg Muni 1-10Yr Blend Index. Data as of 5/31/24.

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DISCLOSURES

Kovitz Investment Group Partners, LLC (“Kovitz”) is an investment adviser registered with the Securities and Exchange Commission. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. The information and opinions expressed in this publication are not intended to constitute a recommendation to buy or sell any security or to offer advisory services by Kovitz. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to participate in any trading strategy, and should not be relied on for accounting, tax, or legal advice. This report should only be considered as a tool in any investment decision matrix and should not be used by itself to make investment decisions.

Kovitz Investment Group Partners, LLC (“Kovitz”) claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Kovitz has been independently verified by The Spaulding Group for the periods January 1, 1997 through December 31, 2022. The verification report(s) is/are available upon request. A firm that claims compliance with the GIPS standards must establish policies and procedures for complying with all the applicable requirements of the GIPS standards. Verification provides assurance on whether the firm’s policies and procedures related to composite and pooled fund maintenance, as well as the calculation, presentation, and distribution of performance, have been designed in compliance with the GIPS standards and have been implemented on a firm-wide basis. Verification does not provide assurance on the accuracy of any specific performance report. GIPS® is a registered trademark of the CFA Institute. CFA Institute does not endorse or promote this organization, nor does it warrant the accuracy or quality of the content contained herein.

Opinions expressed are only our current opinions or our opinions on the posting date. Any graphs, data, or information in this publication are considered reliably sourced, but no representation is made that it is accurate or complete, and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. Past performance is not indicate of future results, which may vary.