Like Winter Storm Jonas, which has disrupted life on the East Coast with up to 30 inches of snow in some cities, strong levels of volatility are sweeping through global markets, from the U.S. to China. The Shanghai Composite Index closed at a 13-month low on Tuesday, while the S&P 500 Index has lost over 7 percent year-to-date.
And with more storm clouds brewing on the horizon, many investors are looking for ways to help them batten down the hatches.
Many investors, sensing additional risk in stocks, have been able to find shelter in municipal bonds, which in the past have provided a certain level of stability in times of turmoil. It’s important to be aware, though, that interest rates and bond prices have an inverse relationship. When one rises, the other declines, and vice versa.
Munis also come equipped with attractive tax advantages, shielding investors from taxes at the federal level and often at the state and local levels too. That means they can help “Obamacare-proof” your interest from the 3.8 percent Affordable Care Act (ACA) tax on investment income (applicable to those who make more than $200,000 in taxable income per year).
In 2015, munis, as represented by the Barclays Municipal Bond Index, were actually the top fixed-income asset class, beating both Treasuries and corporate debt. But they also outperformed S&P 500 stocks, gaining more than double what equities delivered.
Our own Near-Term Tax Free Fund (NEARX) saw its 21st straight year of positive returns in 2015, a rare accomplishment that has been achieved by only 39 out of 31,306 equity and fund bonds—around 0.12 percent—according to Morningstar data.
For more than two decades, we’ve continued to deliver this exceptional level of performance, whether rates were falling or, as is the case now, rising. NEARX invests in short-term municipal bonds, which are much less sensitive to these changes.
Demand Likely to Climb Higher
Billions of dollars fled domestic equity funds on a near-weekly basis in 2015 as investors anticipated a rate hike, which the Federal Reserve finally implemented in December. Meanwhile, muni fund inflows gained momentum in the second half of the year as global stock markets began to show signs of trouble.
So far this year, investors are piling into the $3.7 trillion muni market at a rate of about $1 billion per week.
According to Kiplinger’s 2016 Outlook for Municipal Bonds, incremental rate hikes pose much less downside risk to municipal bonds than to Treasuries of equivalent maturities. In the past, Kiplinger says, the market value of munis has fallen between 50 and 60 percent less than the market value of Treasuries has fallen. Government bonds have typically been more sensitive to changes in U.S. interest rates, as they have a much higher proportion of foreign buyers and sellers from countries where local rates might be more stable or moving in the opposite direction. Supply and demand in the muni market, limited mostly to U.S. buyers, is much tighter.
We’ve managed to provide investors with 21 straight years of positive growth in not only various interest rate environments but also in equity bull markets and bear markets.
If a hypothetical $100,000 had been invested in both NEARX and S&P 500 stocks at the end of 1999, it would have taken 13 years for the equities to climb ahead. (Figures include reinvestment of capital gains and dividends, but the performance does not include the effect of any direct fees described in the fund’s prospectus which, if applicable, would lower your total returns.)
Granted, the two major drops in value during this period—first when the tech bubble burst, then during the financial crisis—were among the worst the market has ever witnessed, investors shouldn’t expect NEARX to outperform at all times. Also, we just ended a phenomenal seven-year equity bull run. What the chart above shows is that the fund has historically demonstrated a greater likelihood of dodging the dramatic swings the equity market has experienced in times of uncommonly high volatility.
Expense ratio as stated in the most recent prospectus. The expense cap is a contractual limit through April 30, 2016, for the Near-Term Tax Free Fund, on total fund operating expenses (exclusive of acquired fund fees and expenses, extraordinary expenses, taxes, brokerage commissions and interest). Performance data quoted above is historical. Past performance is no guarantee of future results. Results reflect the reinvestment of dividends and other earnings. For a portion of periods, the fund had expense limitations, without which returns would have been lower. Current performance may be higher or lower than the performance data quoted. The principal value and investment return of an investment will fluctuate so that your shares, when redeemed, may be worth more or less than their original cost. Performance does not include the effect of any direct fees described in the fund’s prospectus, which, if applicable, would lower your total returns. Performance quoted for periods of one year or less is cumulative and not annualized. Obtain performance data current to the most recent month-end at www.usfunds.com or 1-800-US-FUNDS.
Bond funds are subject to interest-rate risk; their value declines as interest rates rise. Though the Near-Term Tax Free Fund seeks minimal fluctuations in share price, it is subject to the risk that the credit quality of a portfolio holding could decline, as well as risk related to changes in the economic conditions of a state, region or issuer. These risks could cause the fund’s share price to decline. Tax-exempt income is federal income tax free. A portion of this income may be subject to state and local taxes and at times the alternative minimum tax. The Near-Term Tax Free Fund may invest up to 20% of its assets in securities that pay taxable interest. Income or fund distributions attributable to capital gains are usually subject to both state and federal income taxes.
Investors should be aware of risks involved in corporate bonds, such as default risk, credit risk, liquidity risk and economic risk. These risks increase with high-yield, or so-called “junk,” bonds. Although U.S. Treasury bonds are often referred to as risk-free, they do carry certain risks such as opportunity risk, interest rate fluctuations and rising prices. Stock markets can be volatile and share prices can fluctuate in response to sector-related and other risks.
The Barclays Municipal Bond Index is an unmanaged index representative of the tax-exempt bond market. The Shanghai Composite Index (SSE) is an index of all stocks that trade on the Shanghai Stock Exchange. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.