Untapped Value in High-Yield Fixed Income: Municipal Bonds and Structured Credit in the 8% Yield Environment

The current 8% yield environment has created a unique landscape for fixed-income investors, where traditional safe havens like Treasuries offer diminishing returns. Amid this backdrop, overlooked sectors such as municipal bonds and structured credit instruments (e.g., CLOs, ABS) present compelling opportunities for income generation and risk-adjusted returns. These markets, often undervalued or misunderstood, are now offering yields that defy conventional wisdom, driven by technical dynamics, resilient credit fundamentals, and evolving investor demand.

Municipal Bonds: A Tax-Exempt Yield Premium

Municipal bonds have long been a cornerstone of tax-advantaged income strategies, but their appeal has intensified in 2025. The municipal yield curve has steepened sharply, with short-term yields declining by 10–70 basis points and long-term yields rising by up to 70 basis points year-to-date [1]. This divergence reflects a surge in new-issue supply—$256 billion through June 2025—combined with robust investor demand for longer-duration assets [2]. For instance, Pennsylvania Turnpike Commission revenue bonds with 5% coupons maturing in 2050 are now trading at par, offering a 5% tax-exempt yield [1]. At a 35% tax rate, this translates to a taxable-equivalent yield of 7.7%, outperforming many corporate bonds.

The resilience of municipal bonds is underpinned by strong credit fundamentals. State and local governments have bolstered rainy day funds to historically high levels, while default rates remain near record lows [2]. Despite a -1.14% return for the Bloomberg Municipal High Yield Index in Q2 2025, long-end munis have outperformed, with 30-year AAA-rated bonds yielding 8.5% [3]. This steep yield curve creates a "duration premium," rewarding investors who extend maturities in a buyers’ market [4].

Structured Credit: CLOs and ABS as High-Yield Alternatives

Structured credit instruments, particularly Collateralized Loan Obligations (CLOs) and Asset-Backed Securities (ABS), have emerged as overlooked high-yield opportunities. CLOs, which pool senior-secured corporate loans, offer a layered capital structure with senior tranches (AAA-rated) yielding 1.5–2.5% and equity tranches delivering double-digit returns [5]. In Q3 2025, CLO issuance is projected to reach $215 billion, driven by floating-rate coupons that hedge against rising interest rates and regulatory tailwinds [6]. The average spread for CLOs across the capital stack is 154 basis points, with AAA tranches at 106 basis points—narrower than high-yield bond spreads of 296 basis points [7]. This structural advantage makes CLOs a more efficient source of income in a high-yield environment.

ABS markets have also shown resilience, with sectors like equipment and timeshare financing posting strong growth. Innovations such as granular pool diversification and dynamic credit enhancement have attracted yield-focused buyers, even as subprime auto ABS underperformed [8]. For example, equipment ABS with 7–8% yields and short durations offer a compelling risk-return profile, particularly for investors seeking to avoid the volatility of corporate bonds [9].

Strategic Allocation and Active Management

The key to capitalizing on these opportunities lies in active management and sector-specific expertise. Municipal bonds require careful selection of long-end issues with strong credit profiles, while structured credit demands a nuanced understanding of collateral quality and structural protections. For instance, CLOs with floating-rate loans and conservative leverage ratios (e.g., 70–80% loan-to-value) are better positioned to withstand macroeconomic shocks [10]. Similarly, ABS backed by stable cash flows—such as commercial real estate or education financing—offer more predictable returns than consumer-facing sectors.

Investors must also navigate regulatory and policy risks. The pre-election surge in municipal bond issuance and potential shifts in tax policy could alter the landscape, while trade tensions and inflationary pressures may impact structured credit performance [11]. However, the current environment—marked by steep yield curves, attractive spreads, and resilient credit fundamentals—suggests that these sectors remain undervalued relative to their long-term potential.

Conclusion

In an 8% yield environment, the search for income has become a test of patience and precision. Municipal bonds and structured credit instruments offer untapped value, combining tax advantages, structural resilience, and attractive spreads. For investors willing to look beyond conventional benchmarks, these markets represent a rare opportunity to generate high returns while managing risk. As the year progresses, active strategies that exploit yield curve steepness and sector-specific dynamics will likely outperform passive allocations.

Source:
[1] Weekly fixed income commentary | 08/25/2025, [https://www.nuveen.com/en-us/insights/investment-outlook/fixed-income-weekly-commentary]
[2] Municipal Quarterly Review and Outlook 2Q 2025, [https://am.gs.com/en-us/advisors/insights/article/municipal-quarterly-review-and-outlook]
[3] Unlocking Value in a Steepening Municipal Yield Curve, [https://am.gs.com/en-us/advisors/insights/article/2025/unlocking-value-steepening-municipal-yield-curve]
[4] Top 5 Muni Market Insights 2025: Mid-Year Update, [https://www.newyorklifeinvestments.com/insights/2025-municipal-market-insights-midyear]
[5] Understanding Collateralized Loan Obligations (CLOs), [https://www.guggenheiminvestments.com/perspectives/portfolio-strategy/understanding-collateralized-loan-obligations-clo]
[6] Fixed-Income Structured Products in 2025: Resilience and ..., [https://solvefixedincome.com/fixed-income-structured-products-in-2025/]
[7] CLOs: Positioning for Resilience into the Second Half of the Year, [https://www.vaneck.com/us/en/blogs/income-investing/clos-positioning-for-resilience-into-the-second-half-of-the-year/]
[8] Third Quarter 2025 Fixed-Income Sector Views, [https://www.guggenheiminvestments.com/perspectives/sector-views/q3-2025-fixed-income-sector-views]
[9] The ABCs of Asset-Backed Securities (ABS), [https://www.guggenheiminvestments.com/perspectives/portfolio-strategy/asset-backed-securities-abs]
[10] Q3 2025 Credit Research Outlook Resilience amid risk, [https://www.ssga.com/us/en/institutional/insights/q3-2025-credit-research-outlook]
[11] The Pre-Election Municipal Bond Issuance Boom, [https://www.aberdeeninvestments.com/en-us/investor/insights-and-research/the-pre-election-municipal-bond-issuance-boom]