Puerto Rico’s downgrade to junk this month influences investors nationwide as the U.S. commonwealth’s debt is held in 70% of municipal mutual funds. Money managers for high- net-worth clients say they’re more focused on the improving fiscal outlook for mainland issuers. States and cities benefiting from a growing economy are mending their finances almost five years after the longest recession since the 1930s.
Last year’s rally in stocks helped drive municipal debt to the worst annual losses since 2008. Now, less than two months before the deadline for filing individual returns, tax-exempt securities are gaining appeal as some top earners face levies on debt interest payments are as much as 24% higher than for 2012.
“People are going to be shocked by their tax bills this year,” said
Increased demand from individuals, who own about 60% of the municipal market either directly or through mutual funds, may add momentum to a 2014 rally in local debt that has driven benchmark yields close to the lowest since June. Munis have earned 2.8% this year, after a 2.6% drop in 2013, S&P Dow Jones Indices show.
Detroit’s record bankruptcy filing in July and bets on rising interest rates fueled
“All of the selling has created opportunities,” said
Individuals usually buy munis for their tax-free income. The bonds are generally exempt from federal, state and local taxes for residents in most states where they’re issued.
This year, high earners face bills due by
The increases coincide with a new 3.8% tax on investment income applied to top earners last year as a result of the 2010 health-care law.
“With tax rates at these high levels, long munis offer investors attractive after-tax income,”
With the top federal tax rate reaching 43.4% when including the new tax on investment income, the 2.61% yield on benchmark 10-year munis is equivalent to a taxable interest rate of 4.61%. Treasuries of that maturity yield 2.74%.
As clients increasingly demand tax-free income, municipal credit is strengthening, said
“State governments are improving and improving at a dramatic pace,” he said.
Tax collections have probably grown for 16 straight quarters, according to the
The firm’s typical client has about
For some advisors, the extra yield on
Debt of the self-governing commonwealth has rallied as officials said they plan to issue about
S&P cut the island to speculative grade on
“Any coupon above 5% would be a wonderful opportunity,” Hayes said.
For advisors such as
He said he’s looking for revenue bonds with a AAA rating or two steps lower, that yield at least 3.5% and have durations of five to 10 years.
“People are crossing the 50% threshold,” he said of combined federal and state levies. “The idea of sheltering income becomes more attractive and the intrinsic value of munis becomes more attractive.”
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