Amid today’s complex market backdrop, where inflation, interest rates, and taxes all tug at the same thread, we believe few public asset classes offer the rare combination of reliability and reward that municipal bonds do.
By thoughtfully including exposure to the national municipal bond market, we are not just pursuing higher yields, rather we are reinforcing the foundation of what we believe are optimized risk adjusted returns and tax-smart growth that supports our approach to holistic portfolio management.
Recently, LGT Financial Advisors modified our public fixed income allocation by incorporating exposure to the national municipal bond market in place of the aggregate bond index. This decision reflects our view that municipal bonds currently offer compelling relative value compared with the broader taxable bond market.
Elevated nominal yields, strong credit fundamentals, and favorable after-tax income dynamics make the sector an attractive opportunity for investors seeking tax-efficient income and high-quality diversification within portfolios.¹
Municipal bonds, or “munis,” have long been a cornerstone for investors seeking income exempt from federal taxes and, in some cases, from state and local taxes. We focus on the national municipal market rather than state-specific funds, allowing for greater diversification and flexibility across a wide range of issuers and regions.
This approach avoids concentration in any single state or municipality and provides access to a broader opportunity set in a market that remains both deep and diverse.²
Municipal bonds continue to demonstrate strong credit quality. Historically, investment-grade municipal issuers have had extremely low default rates, supported by stable tax bases, essential service revenues, and prudent financial management by state and local governments.
These characteristics make municipals one of the most reliable segments of the fixed income universe, especially in periods of market uncertainty.³
Over the past year, the relative attractiveness of municipal bonds has improved meaningfully. The municipal yield curve has steepened, offering better compensation for extending maturities, while the ratio of municipal yields to comparable U.S. Treasury yields has risen above long-term averages.
This trend indicates that municipals currently provide higher income potential than usual relative to Treasuries and taxable investment-grade bonds.¹ For investors focused on maximizing income while managing risk, these dynamics present a favorable opportunity.
When comparing municipal bonds with taxable fixed income investments such as those represented by the Bloomberg U.S. Aggregate Bond Index, it is essential to consider tax-equivalent yield. This measure adjusts a tax-free yield to its taxable equivalent, reflecting what a taxable bond would need to yield to match a municipal bond’s after-tax income.
For example, an investor in the 35% combined federal and state tax bracket earning a 4.5% tax-free yield from municipal bonds would need to earn approximately 6.9% on a taxable bond to achieve the same after-tax return.
With the Aggregate Index currently yielding around 4.1-4.3%, municipal bonds offer a clear after-tax advantage for tax-sensitive portfolios.¹
At current levels, many diversified municipal bond funds yield between 4-5% tax-free, which translates into tax-equivalent yields exceeding 7% for investors in higher tax brackets. This favorable yield environment has been a key factor behind our decision to allocate to municipal bonds.⁴
We utilize funds that provide diversified exposure to the national municipal bond market with active management, rigorous credit analysis, and broad sector coverage.
Rather than purchasing individual municipal bond, which can present challenges related to liquidity, pricing transparency, and diversification, we use institutional-class mutual funds managed by an experienced municipal bond team. These managers actively evaluate credit fundamentals, yield-curve positioning, and call risk while seeking to capture incremental yield opportunities in a disciplined approach.²
It is important to note that municipal funds have slightly longer duration than the Bloomberg U.S. Aggregate Bond Index, which means they are more sensitive to changes in interest rates.
We believe this additional duration is acceptable given the higher nominal and tax-equivalent yields available in the municipal market. The funds’ yield advantage provides a meaningful cushion against rate volatility, and active management allows duration exposure to be adjusted as market conditions evolve.
Municipal bond funds also provide diversification benefits that complement other fixed income holdings. Performance is influenced primarily by local and regional fiscal conditions, rather than corporate profit cycles or global credit spreads.
This distinction helps municipals behave differently from corporate or Treasury securities, ultimately reducing overall portfolio volatility. Historically, municipal bonds have also demonstrated low correlation with equities, which supports their role as a stabilizing force within balanced portfolios.³
In general, municipal bond funds now account for 20% of total fixed income holdings in a given portfolio. The remaining allocation continues to include diversified taxable investments like high yield and floating rate.
This blended approach provides broad exposure to the taxable bond market while enhancing tax efficiency and income generation through municipals.¹
We continue to monitor market and policy developments that could affect the municipal sector, including changes in interest rates, fiscal trends among issuers, and potential adjustments to tax policy.
While the overall credit environment remains sound, our reliance on actively managed, nationally diversified municipal bond funds provides the flexibility and oversight needed to navigate changing conditions effectively.²
Our allocation to the national municipal bond market reflects an ongoing commitment to aligning investment strategy with client objectives and current opportunities. The combination of attractive nominal and tax-equivalent yields, strong credit quality, and broad diversification makes municipal bonds a key component of our fixed income strategy.
Using actively managed and nationally diversified municipal bond funds, we believe portfolios are positioned to benefit from favorable market conditions while maintaining flexibility, liquidity, and disciplined risk management.
We believe this allocation will help our clients achieve higher after-tax income, enhanced portfolio stability, and continued capital preservation in a period of persistent interest rate uncertainty.
Municipal bonds are subject to various risks, including purchasing power risk, default risk, and call risk. These risks should be considered when evaluating municipal bonds as part of an investment strategy. Past performance is no guarantee of future results.
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