As the end of the year approaches, investors are starting to think more about how their trades will impact the IRS bill next April, and that could prompt a shift toward funds that promise tax-free income. Municipal bond ETFs are seeing an influx of cash in the final days of 2023, which could be a byproduct of tax loss harvesting. That strategy involves selling losing investments to book the negative return in the current year, with the goal of helping offset taxable gains elsewhere, or up to $3,000 in ordinary income. The process can be applied to both individual stocks and mutual funds. Although bond prices and the S&P 500 have recovered sharply over the past five weeks, many investments still show paper losses for 2023 or the past few years. And when investors are concerned with tax bills, municipal bond ETFs can provide an attractive place to park the money generated from selling losing positions. “Now is the time to do this, and I think moving to active muni ETFs could make sense, especially for clients in the highest income tax brackets,” said Courtney Wolf, fixed income portfolio manager at Capital Group. “These provide tax equivalents [on munis] are quite interesting.” Some investors are already moving their money in that direction. The municipal bond ETF category has seen net inflows of nearly $3 billion in the past month, according to FactSet. The iShares National Muni Bond ETF (MUB) leads the way with about $988 million in net inflows. “I think if you look at it [tax exempt] Fourth quarter ETF flows tend to increase. I feel like this is the result of tax loss harvesting,” said Wolf, manager of the Capital Group Municipal Income ETF (CGMU). Municipal bond payouts are generally tax exempt, although the exact details vary by state and where an individual investor lives. This means that the returns quoted on the funds’ websites and marketing materials are lower than those of many other fixed income products, but the actual income realized is very competitive, especially for wealthier investors. For example, BlackRock says the MUB has a tax-equivalent yield of 5.92%, but a 30-day SEC yield of 3.50%. “The higher your tax rate, the more valuable the exemption is to that investor,” says Adam Weigold, head of municipal strategies at Manulife Investment Management. Munis vs. other bonds Bond prices have risen across the board over the past six weeks, with 10-year Treasury yields falling below 4.3%, down from 5% at the end of October. (Bond prices and yields move in opposite directions to each other.) Municipal bonds are no exception; the price of the MUB has increased by more than 3% in the past month. MUB 1M mountain Municipal bond funds like MUB have risen over the past month. But that doesn’t mean municipal debt always trades in a similar pattern to corporate bonds and government bonds. In addition to different tax treatments, there are nuances between the municipal bond market and other areas of fixed income. One key is that municipal debt carries more credit risk than federally backed government bonds. However, Duane McAllister, managing director at Baird, said the credit quality outlook for municipal debt continues to be supported by the extra money from the Covid relief accounts that many local governments still have. “We’re at a point today where municipal credit is really, really strong,” McAllister said. Another current topic on the bond market is supply. Some traders worry that the large federal budget deficit will push Treasury yields higher as the market struggles to absorb new debt. However, this is not an immediate problem for municipal debts. “We’re missing some of the problems that Treasuries have with over-issuance,” said Manulife’s Weigold. “Our emissions have actually fallen this year. And the credit quality in our market is very strong. I think local government appropriations are probably as strong as they have been, at least based on the numbers I’ve seen in my 25-year career. .” Manulife is one of several asset managers to recently launch a new muni ETF, with its John Hancock unit debuting the John Hancock Dynamic Municipal Bond ETF (JHMU) in November. Other newcomers include Capital Group Short Duration Municipal Income ETF (CGSM) and Dimensional California Municipal Bond ETF (DFCA).In October, Vanguard announced plans to launch two more tax-exempt bond funds.
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