@Invesco.
Charles Moussier, Head of EMEA Insurance Client Solutions, and Stephanie Larosiliere, Senior Client Portfolio Manager, present the case for why they believe US municipal bonds could be worth consideration for inclusion in the portfolios of European insurers.
The piece explains what municipal bonds are, how they can provide a source of diversification as well as some of the tax and liability-matching features that may make them favourable. Click the link below to read.
European-based insurers may find Municipal Bonds are worth including in their portfolios. Municipal bonds are issued by US state and local governments (municipalities), eligible not-for-profit corporations and US territories. When an investor purchases a municipal bond, he or she is lending money to finance a myriad of public projects.
Traditionally, for US domestic investors, municipal bond interest payments are exempt from federal income taxes, and sometimes state income taxes.
Foreign investors, who do not pay taxes in the US, might consider these tax features a drawback rather than an advantage, as nominal yields are driven down by investors who can utilise tax deductions and may therefore focus on taxable issues. Taxable municipal bonds offer higher risk-adjusted yields comparable to those available on other taxable issues, such as corporate bonds.
Issuers may choose to issue a taxable municipal bond for a variety of reasons, including access to a broader investor base, the flexible use of proceeds and the fact that the financed activity is not considered tax-exempt.
Issuers of municipal bonds can also issue debt using corporate CUSIPS to take advantage of the greater liquidity and diverse investor base offered by the corporate market, which municipal issuers typically access to issue longer-dated structures that are attractive to liability-driven investors.
US municipal bonds may be worth consideration as a source of long-dated, high credit quality fixed income and a source of potential diversification within existing credit portfolios.
They also provide access to US infrastructure debt in a publicly available form (revenue bonds) and offer potentially higher yields than similarly rated public credit, with a history of lower default rates, higher recovery rates and attractive relative value compared to European corporate bonds, even after hedging costs.
There are many features of typical municipal bonds that make them an instrument worthy of consideration for matching insurers’ long-term liabilities. Key features when compared to global corporate bonds include lower default rates, stability of ratings, higher recovery rates and predictable long-term income.
Most state and local governments are highly rated, whereas corporate credits tend to have lower average ratings. Accordingly, it is not surprising that municipal default rates have been extremely low, especially when compared to global default rates - the global corporate investment grade default rate is more than 24 times higher than the municipal investment grade default rate.
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