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The Muni Market is Becoming More Concentrated

Retail investors are a staple of the municipal bond market, holding about three-quarters of the nearly $4 trillion in outstanding bonds. But, according to recently released Federal Reserve data, the value of muni bonds directly held by retail investors fell by $18 billion during the fourth quarter of 2021, reaching their lowest levels since 2008.

Many retail investors are turning toward mutual funds and, increasingly, exchange-traded funds (ETFs) for exposure, which offer more diversification and better liquidity than direct ownership. In addition, actively-managed funds can tailor strategies to reduce risk during specific economic cycles or capitalize on opportunities as they arise.

This article will look at how the rise of muni bond funds could impact the market and the most significant funds in the space.

Be sure to check our Municipal Bonds Channel to stay up to date with the latest trends in municipal financing.

ETFs Fuel Liquidity Concerns

Individual investors have historically dominated the municipal bond market. In the past, these investors purchased individual bonds and deducted the coupons until maturity. The problem is that the lack of liquidity and high cost of information translated to high mark-ups on muni trades that are relatively larger than those on corporate bonds.

Over the past couple of years, ETFs have become a popular alternative, with significantly lower fees. In fact, Citigroup estimates ETF muni holdings will grow from $80 billion in 2021 to $125 billion by 2023. On average, ETFs also charge a full percentage point less than open-ended muni bond mutual funds, according to Morningstar Direct data.

While ETFs help reduce costs, they introduce some liquidity concerns. In particular, muni bonds are considerably less liquid than the ETFs that hold them, creating the potential for a liquidity mismatch and gap between the ETF’s net asset value (NAV) and share price. For instance, an ETF issuer may be forced to sell a bond at a discount or buy one at a premium.

These problems could become more severe during a crisis. For example, in March 2020, many ETF managers decided not to sell the underlying bonds, resulting in share prices that outperformed the estimated value of the underlying bond. In some cases, the gap lasted more than two months, although ETFs quickly recovered under pressure.

What Are the Largest Funds?

More than 300 mutual funds and over 30 ETFs offer municipal bond market exposure. At the same time, hundreds of other funds hold muni bonds alongside other fixed income investments.

The largest mutual funds include:


The biggest ETFs include:


Investors should carefully consider each fund’s expense ratio and liquidity before investing. In addition, investors should keep in mind that muni bond ETFs may have significant premiums or discounts to their net asset value. As a result, investors may have an opportunity to acquire ETFs below net asset value.

Don’t forget to check our Muni Bond Screener.

The Bottom Line

The muni market continues to evolve from a retail-driven market to a fund-driven market, making it more like the corporate bond market. While the transition helps reduce fees for investors, the illiquid nature of muni bonds creates potential liquidity issues. As a result, some advisors recommend sticking to mutual funds for muni bond exposure.

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Data as of April 7, 2022

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May 19, 2022