Long-Dated Municipal Bonds: A Winning Opportunity for High-Net-Worth Investors

When it comes to fixed income, the middle or intermediate bonds are often considered the sweet spot offering the perfect blend of duration risk and current yield. However, for high-net-worth families looking at the muni space, they may want to consider the long end of the spectrum.

Long bonds are defined as those with maturities lasting 20 years or more. These bonds feature a high amount of credit and duration risk. To compensate for that, long bonds often have higher yields than short-dated maturities. When it comes to credit risk, munis are generally pretty safe. Afterall, the chances of Texas or New York going bankrupt are pretty slim. They can always increase taxes to pay off their city bills. However, duration risk is high for long-dated bonds. Locking in a coupon rate for 25 years comes with a lot of risk when it comes to changes in interest rate policy.

And we’ve seen that in action over the last year.

Long-dated bonds fall significantly when the Fed raises rates to match newly issued bonds featuring already higher coupons. As the Fed raised rates last year and into 2023, long-dated munis were gutted. Bonds with 22+ years till maturity fell by 15.3% in 2022. Bonds in the 17-to-22-year range fell by 11.2%.

However, that dip in prices just may be what HNW investors are looking for when it comes to their portfolios. With the dip in prices, long-dated bonds are yielding levels not seen in roughly a decade. According to Tradeweb data, long-dated munis (25 to 30 years) that have AAA credit ratings are currently yielding 3.5%. This compares to a 3.89% yield for 30-year Treasury bonds.

Where things get juicy – particularly for investors in high tax brackets – is the so-called tax-equivalent or after-tax yield. For investors in the 33% tax bracket, they would need to earn 5.25% from a bond to get the same amount of income. The effect is greater for those in higher tax brackets and those subjected to the AMT/Obamacare surcharges. This makes long-dated munis a great deal when compared to other income options.

But the potential for long-dated munis doesn’t stop there. There’s future tax considerations to consider. While no one can really predict what’s going to happen to U.S. tax policy, the long-term trend remains higher taxes. With Federal deficits ballooning, gaps in social security widening and new infrastructure spending programs now passed, there’s a lot of ground to make up. With long maturity timelines, long-dated munis could be a great weapon against future tax policy, which is something that HNW can’t ignore.

Then there is the short term to consider. Thanks to lowered rates of inflation and rising recession risk, the Fed may be ready to pause on rate hikes and potentially even cut them before long. This would add plenty of capital appreciation to long-dated munis. The inverse effect is true: long-dated munis tend to rise by a lot during rate cutting environments as investors buy older dated bonds with higher coupons.

While you don’t have to be a HNW investor to get benefits from long-dated muni bonds, the effects are muted. For example, an investor in the 28% tax rate, the current tax-equivalent yield for long bonds falls to just 4.86%. You can easily pick up a higher after-tax yield in cash or T-bills. For HNW investors, however, long bonds make for an ideal play.

For indexers, the pickings are slim. The VanEck Long Muni ETF is really the only ETF that solely covers long-dated bonds. With it, investors can grab a 3.75% yield for just 0.24% in expenses.

Like much of the muni sector, active management can play a real role in boosting returns when it comes to long-dated munis. The problem is, like ETFs, many managers have closed or rolled up their long-term muni funds into their broader offerings. The Vanguard Long Term Tax Exempt Fund is really the only choice in the sector. But luckily, it’s a great active choice, with managers looking strictly at high-quality muni bonds. Vanguard also fields two great long-term muni funds for investors in the high tax states of California and New York. Both the Vanguard California Long Term Tax Exempt Fund and Vanguard New York Long Term Tax Exempt Fund follow a similar strategy as the national fund.

For high-net-worth investors, long-term munis could be a real bargain. Offering high current yields, tax-free income and value, the sector has a lot to offer. And with potential future tax increases down the line, their value grows even further. While getting access is harder than it should be, there are plenty of quality funds to choose from.

Don’t forget to check Long-term muni bond funds page to explore other options.