Aim Higher with Muni Bonds through Actively Managed Ladders
Give a boost to your muni portfolio.
In today’s uncertain interest rate environment, it’s all the more important to manage your municipal bond risk. Enlisting a manager who can actively ladder your muni bond portfolio has the potential to mitigate some of your muni bond risks while providing better diversification, lower turnover and reduced capital gains.
Laddering bond portfolios: a sound strategy
The traditional, basic bond ladder is constructed with staggered maturities so that a portion of the portfolio matures each year. A generally equal investment is maintained in each year of the ladder. Proceeds from maturing short-term (lower yielding) bonds may be reinvested in bonds with longer maturities and (normally) higher yields.
The goal: to achieve a total return that compares favorably to the return of a long-term bond, but with more stable cash flows. The reasoning behind a basic muni bond ladder is sound, and the implementation is pretty straightforward.
Actively ladder for a higher level outcome
Actively laddering a muni bond portfolio demands a level of expertise not required for a basic laddering strategy. By using fundamental, bottom-up credit analysis and seeking relative value across the maturity spectrum, an actively managed ladder can potentially reward investors with enhanced benefits over and above a basic laddered portfolio.
A common muni bond ladder simply equal weights bond maturities across each year of the ladder. Actively managed ladders may consider various market risk metrics, such as the slope of the yield curve, to actively underweight or overweight those maturities considered too expensive or inexpensive, respectively. Varying percentages of the portfolio invested across the muni bond yield curve increases interest rate diversification, which in turn, may reduce rate risk.
Fundamental, bottom-up analysis in muni bonds?
Actively managing a laddered portfolio can also limit reinvestment risk while seeking greater total return. The active strategy may use deep bottom-up credit research to continually assess the risk/reward trade-off across sectors, regions and maturities. The resulting research creates laddered bonds that seek the greatest relative value while still being able to reinvest proceeds from maturing bonds to maintain stable cash flow.
The active approach to laddering muni bond portfolios also offers the benefits of lower turnover and transaction costs, which help reduce capital gains. Because the continual cash flow stream from maturing bonds acts as dry powder, a manager who actively ladders their muni portfolio is able to take advantage of attractive opportunities as they arise, avoiding having to sell securities in order to fund the purchase of bonds, possibly triggering a taxable event. That’s an important consideration for investors who typically invest in munis because of their tax-exempt income. Because most of the bonds are allowed to mature and roll off the ladder, turnover and transaction costs are kept low.
Actively laddering municipal bond portfolios can enhance the advantages of a proven and sound strategy while potentially increasing protection amid greater uncertainty in the muni bond landscape.