Foreign investors are showing their affection for U.S. municipal bonds as they step up their recent buying spree, according to report released by Van Eck on Tuesday.
"Foreign holdings of debt issued by U.S. states and local governments rose 16% in the last quarter of 2016, reaching a record level of $106.4 billion," Michael Cohick, Van Eck's product manager for exchange traded funds, wrote in the report.
"While foreign ownership represents just a small fraction of the $3.8 trillion U.S. municipal bond market, it is a growing segment that has risen steadily since 2000," he wrote. "In the past two years alone, foreign ownership of muni bonds has increased 32%, from $80.6 billion at the end of 2014 to its present $106.4 billion."
The muni tax-exemption is one of the key draws for American-only investors, and foreign buyers don't benefit from it. But that's not deterring overseas investors as they eye the yields from U.S. munis.
"The attractive yields of U.S. municipal bonds are proving to be attractive to yield-starved foreign investors who struggle to find comparable yields at home," Cohick said.
Municipal bonds are also attractive because they are seen as safe havens, being similar to U.S. Treasuries, with near-zero default rates.
"We believe the safe haven reputation is well deserved," Cohick said. "Although, unlike U.S. Treasuries, muni bonds are not guaranteed by the full faith and credit of the U.S. government, according to Moody's Investors Service, the 1970-2015 average cumulative 10-year default rate for all rated muni bonds was a tiny 0.15%. In comparison, all rated global corporate bonds averaged a 10.16% 10-year default rate over the same period. What's more, muni bond yields can sometimes be higher than U.S. Treasuries and corporates."
The report said that munis' higher yields, low historical default rates, and diversification benefits have combined to create a "perfect storm" of overseas interest.
"Demand for munis has generally outstripped supply for some time now," Cohick said. "This demand for muni bonds could potentially encourage more issuers to enter the market, both issuers of tax-exempt and taxable bonds."