The U.S. corporate and municipal bond markets seemed to be neck and neck in terms of total return performance for the first three quarters of 2017. However, distinct characteristics of both markets that have played key roles in driving performance could cause performance to vary significantly going forward.
Let’s take a look at some of the potential performance drivers and differentiators.
Coupon cash flow: As of September month-end, investment-grade taxexempt municipal bonds tracked in the S&P National AMT-Free Municipal Bond Index had an average coupon of 4.61% vs. the average coupon of 3.72% of the bonds in the S&P 500®/MarketAxess Investment Grade Corporate Bond Index.1 In a low-yield and low-expected-return environment, municipal bonds offer higher-interest-rate cash flow that is tax-exempt. Advantage: municipal bonds.
Yield: Investment-grade tax-exempt municipal bonds on average have yielded 2.03% vs. higher-yielding taxable investment-grade corporate bonds. However, looking at it from the perspective of taxable equivalent yield (TEY), municipal bonds have recently been at higher yields than their corporate bond equivalents.2 Please refer to table on next page. Advantage: municipal bonds.
Duration: Investment-grade corporate bonds from the companies of the S&P 500 are tracked in the S&P 500/MarketAxess Investment Grade Corporate Bond Index. Their average duration has been over 7.75 vs. an average of 4.8 for investmentgrade municipal bonds tracked in the S&P National AMT-Free Municipal Bond Index.3 In general, in a rising rate environment the lower duration favors municipal bonds. Advantage: municipal bonds.
Market size: U.S. corporate bonds that are index-eligible tend to be very large issues. The market size of the corporate bond market tracked in the S&P 500 Bond Index, a broad index, is over USD 4.5 trillion.4 The broad S&P Municipal Bond Index tracks over USD 1.77 trillion of the USD 3.8 trillion municipal bond market.5 The larger corporate bond market tends to be more liquid.
