Municipal Bonds: Steady Anchors in a Volatile Market

The global investment landscape is increasingly turbulent, with corporate defaults spiking to post-financial-crisis highs and equity markets oscillating like a pendulum. Amid this chaos, municipal bonds—a stalwart of conservative portfolios—stand out for their resilience, offering investors a rare blend of safety and yield. With default rates at a mere 1.2% of issuers as of early 2025, muni bonds are proving their mettle as a strategic diversifier. Here's why they belong in every investor's toolkit and how to navigate their nuances.

The Ironclad Case for Low Defaults

The municipal sector's structural strength is its bedrock. Through early 2025, only 59 issuers out of over 37,000 had defaulted, with Chapter 9 bankruptcies at a 16-year low. Defaults are concentrated in non-essential sectors like nursing homes and charter schools, while core issuers—cities, utilities, and water systems—maintain pristine credit. Moody's and S&P's upgrade/downgrade ratios for most sectors, including hospitals and higher education (excepted for their unique challenges), reflect this stability.

Tax Advantage: A Lifeline for High-Income Earners

Municipal bonds' tax-exempt status delivers outsized benefits for investors in the top federal tax brackets. Consider this: a bond yielding 3.5% in a 37% tax bracket offers a 5.5% equivalent yield for taxable bonds. For states like California or New York with high state income taxes, the advantage compounds further. Even middle-income earners find value—especially with 2025's rising rates.

Supply and Demand: A Bullish Tailwind

Despite concerns about oversupply, the muni market's demand remains robust. Infrastructure spending and climate adaptation projects are driving issuance, but investor appetite is growing faster. Technical factors like higher M/T ratios (maturities relative to trading volume) and tightening credit spreads favor active managers who can pick high-quality credits.

GO vs. Revenue: Choosing Your Exposure

General Obligation (GO) bonds—backed by issuers' taxing power—are the safest bet, ideal for risk-averse investors. Revenue bonds, tied to specific projects (e.g., toll roads, utilities), offer higher yields but require due diligence. Focus on revenue bonds in essential sectors: utilities now boast improved debt-service coverage ratios post-pandemic, while airports and toll roads are rebounding strongly.

Avoid revenue bonds in non-essential sectors like housing or higher education, where defaults have surged.

Actionable Funds: Where to Park Your Money

Morningstar's top-rated funds and ETFs simplify access to this sector:

1. Hartford High Yield Municipal Bond Fund (HHMIX): A five-star fund with a 15-year track record, emphasizing high-quality credits and short-duration strategies to mitigate interest rate risk. Its 4.1% yield (as of Q2 2025) balances risk and reward.
2. VanEck Vectors Municipal ETF (MUB): A broad-market ETF with a 2.8% yield, offering diversification across GO and essential revenue bonds. Its liquidity and low fees make it ideal for core allocations.

The Fine Print: Risks to Monitor

While muni bonds are sturdy, no asset is risk-free. Federal policy shifts—like changes to the SALT deduction or Medicaid funding—could disrupt certain issuers. States like Illinois or cities with budget gaps (e.g., Chicago) warrant caution. Diversify by issuer and sector, and favor funds with strict credit discipline.

Conclusion: A Steady Hand in Uncertain Waters

In a world of volatility, municipal bonds are more than a niche investment—they're a strategic cornerstone. Their low default rates, tax advantages, and current demand dynamics make them a compelling hedge against market turbulence. By focusing on GO bonds, essential revenue sectors, and top-rated funds like HHMIX and MUB, investors can secure steady returns without overexposure to risk. As always, vigilance is key: monitor federal policy shifts and issuer credit metrics. In 2025, muni bonds are not just safe—they're smart.

Investment thesis: Allocate 10-20% of a fixed-income portfolio to municipal bonds, prioritizing short- to intermediate-term funds for yield and liquidity.