Active & Passive Falling Rates Municipals Fixed Income Blog

Three Reasons Why It Pays to Be Active as a Muni Investor

Feb 05, 2025
4 min read
Three Reasons Why It Pays to Be Active as a Muni Investor
Daryl Clements| Municipal Bond Portfolio Manager—Municipal Fixed Income
Jason Mertz| Investment Strategist—Municipals

In today’s era of automation, some situations demand a more active approach. Municipal bond investing is one.

The municipal bond market is inefficient, fractured and constantly in flux, and active muni investors are much better equipped to navigate it than are passive ones—an advantage that we believe can improve outcomes.

In fact, we found that—historically—an astonishing 98% of active muni strategies have meaningfully outperformed passive approaches over rolling three-year periods, and 89% have outperformed passive strategies over two-year periods. Further, active strategies delivered better upside and downside capture through some very volatile markets. Here’s why.

Active strategies can proactively align with market shifts and dislocations, while passive approaches cannot. By continually adjusting a portfolio, active investors can flex with current conditions, better manage risks and capture opportunities as they arise.

As we see it, much of the active muni manager’s edge comes from three strategies: yield-curve and duration positioning, municipal credit selection, and dynamic sector rotation, especially into Treasuries. 

Yield-Curve Positioning: Responding to Shifts and Shapes

The shape and slope of the yield curve frequently change in response to economic growth expectations, inflation expectations, central-bank policies and more.

Active managers may choose to own different combinations of maturities along the municipal yield curve to take advantage not only of relative yield levels but also of expectations for changes in the shape of the yield curve down the road. Whether a barbell, ladder or concentrated position, there’s no “all weather” maturity structure, because different environments call for different approaches.

For example, a barbell maturity structure invests in short- and longer-term muni bonds, while minimizing exposure to the middle of the curve. A barbell structure fared well in 2024 as the yield curve shifted (Display, left), providing higher returns relative to concentrated and ladder approaches (Display, right).

Barbell Outperformed Other Structures as Yields Shifted in 2024
A barbell maturity structure retuned 1.69%, vs. 1.07% and -0.16 for ladder and concentrated, respectively.

For illustrative purposes only. Historical analysis does not guarantee future results.
Maturity structures were created using relevant maturity buckets and the Bloomberg Municipal Bond Index; yield to worst and duration as of December 31, 2023.
Through December 31, 2024 
Source: Bloomberg, Municipal Market Data and AllianceBernstein (AB)

With today’s curve reverting toward a more normal shape, we think a modified barbell structure that includes select intermediate bonds can help investors capture attractive yields while enjoying a potential price boost.

Concentrated and laddered maturity structures are good fits for other circumstances. A concentrated, or bullet, structure invests in a very narrow maturity range. By contrast, a laddered portfolio spreads bond holdings evenly across maturities.

Credit Selection: Leaning In (or Out) as Needed

Income is a key contributor to muni returns, and active strategies can take advantage of a broad muni universe to help maximize it. One way to boost income is by strategically adding municipal credit.

Muni credit, which includes non-investment-grade, BBB-rated and A-rated issues, historically has offered significantly more yield than the highest-quality bonds (Display, left). We believe muni credit will continue to offer attractive income, backed by strong issuer fundamentals. For instance, we’re seeing consistently healthy balance sheets (Display right), which is a key reason why municipal bond defaults in general are rare.

Muni Credit: Fiscally Sound, Higher Yields
Yield spreads between AAA-rated and High Yield munis haves been consistent, as has the financial health of states.

Historical analysis does not guarantee future results.
AAA bonds represented by the AAA-rated subset of the Bloomberg Municipal Bond Index. High yield represented by the Bloomberg Municipal High Yield Index.
Through December 31, 2024
Source: Bloomberg, National Association of State Budget Officers and AB

While credit spreads have tightened, we currently see opportunities in select sectors such as prepay energy, affordable housing and utility districts. The credit universe isn’t static, so we think investors should stay selective when leaning in.

Dynamic Sector Rotation: Active’s Incremental Leg Up 

For investors subject to high tax rates, municipal bonds have generally made sense over the years, as they do today. But market technicals such as supply and demand can make relative after-tax yields highly variable over time. In fact, tax-advantaged muni yields have occasionally been lower than after-tax yields for Treasuries (Display).

When Treasuries Yield More than Munis, Active Investors Can Selectively Add Them
A line chart shows how the yield relationship between Treasuries and muni bonds ebbs and flows over time.

Historical analysis does not guarantee future results.
Assumes a 40.8% tax rate
Through December 31, 2024
Source: Bloomberg, Municipal Market Data and AB

As we see it, this ongoing dynamic presents opportunities for nimble investors. For example, when spreads suggest that munis are becoming too expensive relative to Treasuries, a small opportunistic position in Treasuries may be appropriate. Conversely, rotating away from Treasuries and back into high-grade municipals seems prudent when spreads widen and munis are again considered fairly valued or relatively cheap.

From mapping the yield curve to thoughtful sector and security selection, small ongoing adjustments can have a big impact on a municipal bond portfolio. As we see it, capturing higher after-tax yields, managing volatility and having the dry powder to lean back into munis when needed can all lead to better outcomes. That’s why we believe staying active matters and flexibility pays off in the end.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

About the Authors

Daryl Clements is a Senior Vice President and a Municipal Bond Portfolio Manager on AB’s Municipal Fixed Income team, where he is responsible for overseeing the firm’s various separately managed accounts (SMA) and mutual fund assets. He joined AB in 2002 as a municipal credit research analyst, responsible for evaluating municipal issuers nationwide, with a particular focus on the transportation, public power and tobacco-backed bonds sectors. In 2006, Clements was promoted to the portfolio-management team and became a member of the Tax-Exempt Fixed Income Investment Policy Group. Since that time, municipal assets under management have increased from US$22 billion to nearly US$80 billion. Within that growth, Clements spent considerable time expanding and broadening the team’s SMA business. Prior to joining the firm, he was an associate director and municipal credit analyst for Financial Guaranty Insurance Company for six years and a municipal research associate for five years before that with Moody’s Investors Service. Clements holds a BS in business, management and finance from Brooklyn College and an MBA in finance from Pace University. In 2008, he co-authored the “How to Analyze Airport Revenue Bonds” chapter in The Handbook of Municipal Bonds. Location: New York

Jason Mertz is a Vice President and Investment Strategist for AB’s Municipals team, covering all mutual funds, exchange-traded funds and separately managed account solutions. He works extensively with the firm’s portfolio management, credit research and trading team to monitor and communicate portfolio positioning and analysis to clients around the US. Prior to joining AB in 2016, Mertz worked at BlackRock as a separately managed account analyst. He holds a BA in finance and international business from Muhlenberg College. Location: New York

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