A bunker is defined by Webster Merriam as a strong building that is mostly below ground designed to keep soldiers, weapons, and supplies safe from enemy attacks. And while the investment landscape is not a warzone, it’s no secret that 2016 has been a battlefield for many investors. January greeted us with remarkable volatility and we kicked off the summer with market chaos upon the unprecedented outcome of a Brexit referendum, in which the United Kingdom voted to leave the European Union. So now here we are in August and investors are a little battered and the global economy is a little bruised. Surely the potential for an investment bunker would be a welcome reprieve for many of us. This is where we believe municipal bonds (munis) come into play.
After the Brexit vote was announced currency markets took a nose dive, equities entered a tailspin, and the global economy was briefly shell shocked. Yet in the midst of the initial Brexit fallout munis were rallying. But this isn’t a 15 minutes of fame story. Munis have had a strong year, reporting 43 consecutive weeks of positive net fund flows as of Friday, July 29 – making this the fourth longest streak since 1992 both in terms of consecutive weeks and dollar amount. In fact, defying conventional wisdom, munis outperformed equities, investment grade corporate bonds and even Treasurys in the days immediately following the Brexit vote and have continued to provide investors with consistent performance. And while I don’t buy into the hype surrounding the muni/Treasury ratio, it’s becoming hard to ignore the sharp outperformance in munis – especially out long.
But it isn’t just the performance of munis that is attractive. In a global economy, where many countries are facing very low, if not negative, yields, municipal bonds are appealing to foreign investors. Additionally, in times of market uncertainty we often see flight-to-quality, or investors moving their capital from riskier investments to safer investments, a role well suited for fixed income investments, notably munis, in an investment portfolio.
And while I want to be clear that municipal bonds are not without risk, in an environment where rates look to be on the path of “lower for longer” investing in munis becomes attractive, as munis are designed to provide stable and superior tax-adjusted yields relative to taxable products. In fact, if we remain bogged down in this low interest rate environment, or if rates are reduced further, investors have the opportunity for their investment to appreciate through active management (buying and selling muni bonds as opportunities arise, rather than holding to maturity). And in the wake of Brexit, many believe that rate hikes by the Federal Reserve are now off the table for the foreseeable future, which is good news for muni bond investors.
Now some may point to a reduced demand from direct retail and it’s true that direct ownership of muni bonds has fallen nearly 20% since 2008. However, ownership in muni mutual funds has risen by 37%. In fact, institutional interest in municipal bonds remains strong, healthy, and growing- serving as a nice reminder that bonds still matter. But the important thing to remember is that you should own bonds for more than just income. Meaning the diversification benefit alone is a proven staple of a well-balanced portfolio. And balance is great, in fact it is necessary, but as an investor you should balance with bonds that can weather the storm. And when we look back on the year-to-date performance of munis through June, municipal bonds have surpassed the annual returns in seven of the last ten years. The takeaway? If you are looking for a Brexit bunker, and believe in the benefits of diversification, consider fortifying your long-term investment strategy with municipal bonds.
Unless otherwise noted, the information in this document has been derived from sources believed to be accurate as of August 2016. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity. Past performance is not necessarily indicative or a guarantee of future performance and should not be relied upon to make an investment decision.
The information in this document contains general information only on investment matters. It does not take account of any investor’s investment objectives, particular needs or financial situation and should not be construed as specific investment advice, an opinion or recommendation or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding a particular investment or the markets in general. All expressions of opinion and predictions in this document are subject to change without notice. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that Principal Global Investors or its affiliates has recommended a specific security for any client account.
Principal Financial Group, Inc., Its affiliates, and its officers, directors, employees, agents, disclaim any express or implied warranty of reliability or accuracy (including by reason of negligence) arising out of any for error or omission in this document or in the information or data provided in this document.
Third party content, such as comments to this blog, is not reviewed by Principal Global Investors before it is displayed, although we may remove, alter, edit or adapt any such comments. Principal Global Investors does not endorse, authorize, or sponsor any third party content. Links contained in some blog posts may take you to third-party sites and Principal Global Investors makes no guarantees to the accuracy of the information provided.
Investing involves risk, including possible loss of principal. Fixed-income investments are subject to interest rate risk; as interest rates rise their value will decline. International and global investing involves greater risks such as currency fluctuations, political/social instability and differing accounting standards. A portion of the Fund’s income may be subject to state and/or local taxes, and it may be subject to federal alternative minimum tax (AMT) for certain investors.
Principal Funds are distributed by Principal Funds Distributor, Inc.