Higher potential after-tax returns
Corporate Bonds vs. Municipal Bonds
Many investors in high tax brackets favor muni bonds because they believe they can
achieve higher after-tax returns.
When BondSavvy recommends corporate bonds, we are focused on maximizing each
investment's total return, which includes
a bond's capital appreciation and interest income. Given the more favorable tax
treatment of capital gains vs.
interest income, our total return strategy can achieve higher after-tax returns than munis
We believe it is easier to identify capital appreciation opportunities in corporate
bonds vs. muni bonds given the
superior and more frequent financial disclosures required of corporate bond issuers.
Corporate bond issuers must
report financial results four times per year and report material events through 8-K
filings with the US Securities
and Exchange Commission (SEC). Municipal bond issuers typically provide annual filings,
so it's difficult to
assess a municipal bond issuer's health over the course of a year.
For example, on December 10, 2020, we did a search for the financial reports of the New
Jersey Turnpike Authority, a large
issuer of revenue bonds in the home state of BondSavvy founder Steve
On this date, the most recent historical financials we could find were for the year
ending December 31, 2019.
While some budgeted 2020 numbers were provided, we have gone nearly an entire year from
the end of 2019 without newly
reported financial statements. This is par for the course for municipal bond issuers.
We identify bonds that can achieve strong total returns by determining if a potential
corporate bond investment is undervalued
relative to comparable corporate bonds. We calculate leverage ratios and other key metrics
and compare these to a corporate bond's price, yield to maturity, and credit
spread to determine whether the potential bond investment
has upside potential and can achieve a strong total return.
Easier to buy and sell
Corporate vs. Municipal Bonds
Individual corporate bonds trade in a robust marketplace where typically 6 to 10
dealers are posting live bid-offer quotes
for each bond CUSIP, a nine-digit bond identifier. It is a technology-enabled
marketplace with reasonable bid-offer
spreads as shown in the below table, which shows quotes available on Fidelity.com for
the Alphabet 1.998% 8/15/26 bond
(CUSIP 02079KAC1), which BondSavvy previously recommended (click here to view this recommendation during the sample edition of The Bondcast
For this corporate bond, 10 dealers were providing live bid-side quotes while nine
were providing live offer-side quotes.
The bid-offer spread is narrow, as it is 0.20 points, on a dollar-price basis (94.550
less 94.350), and 3 basis points
(0.03 percentage points), on a yield-to-maturity basis, calculated by taking 2.857% less
These narrow bid-ask spreads are driven by the high level of competition among the
quoting dealers, all of which are vying
for your corporate bond trades.
Corporate bonds are in stark contrast to muni bonds, as munis do not have a live
bid-offer market with multiple dealers
quoting. Instead there is one dealer quoting only
on the offer side, which
makes it hard to know the
price at which you can sell the bonds.
This superior liquidity makes it easier to buy and sell individual corporate bonds
vs. municipal bonds.
Individual Corporate Bonds vs. Municipal Bonds
Investors are always learning more about corporate bond issuers through quarterly
earnings releases, investor presentations,
executive interviews, and other SEC filings. This enables investors to quickly assess
the financial health of a company
and invest accordingly. Municipal bond issuers, on the other hand, have far less
stringent reporting requirements,
often reporting their financials just once per year.
In addition, the pricing of corporate bonds is more transparent than that of
municipal bonds, as corporate bonds enjoy
a robust, two-sided market with between six to nine dealers providing
live-and-executable bid-offer quotes. Municipal
bonds do not have multiple dealers providing live quotes, which can make assessing the
value of a municipal bond more difficult.
Further, since there are thousands of corporate bond CUSIPs compared to millions of
municipal bond CUSIPs, there is a greater
level of trading activity in each corporate bond vs. municipal bonds. Therefore, when
investors search for a specific
bond, they can often see 25 to 50 trades per day taking place in the same bond, which
enables investors to assess the fairness
of the prices being quoted. Since there are so many more municipal bonds, many munis can
go months without trading,
which often makes price discovery an uphill battle for municipal bond investors.
Greater variety of risk/return investments
Corporate Bonds vs. Muni Bonds
Given the wide range of corporate bond credit profiles, we like to say "there's a
corporate bond for everyone." For
example, a May 28, 2019 Fidelity.com corporate bond search returned 7,680
investment-grade bonds (bonds rated at least
Baa3 by Moody's and BBB- by S&P) and 1,357 high-yield bonds, which are rated Ba1/BB+
or lower. With this variety
of credit profiles, investors can create corporate bond portfolios suited to their risk
tolerance and investment returns
On the other hand, municipal bonds generally have only the highest credit ratings
and, as a result, less opportunity for
higher investment returns. In a July 3, 2019 search for municipal bonds available on
Fidelity.com, of the 19,000
bond search results, only 104 had credit ratings lower than an A rating by S&P, and
all of those 104 bonds were rated
BBB+. In addition, while states such as California and Florida have a seemingly
unlimited supply of municipal bonds,
other states such as Delaware, Montana, Mississippi, and New Hampshire have relatively
few offerings. As a result
of these factors, investment choice can be severely constrained for those investors
seeking exemption from state and local
the opportunity for high return investments.
This article reviews our rationale for owning corporate bonds vs. municipal bonds.
As we discuss, higher income and
capital appreciation opportunities are among the reasons investors may elect to own
corporate bonds vs. municipal bonds.
Investors seeking income and capital appreciation opportunities may also wish to explore
owning dividend stocks and may
be interested in the following dividend stock websites:
Monthly Dividend Stocks