Banks and mutual funds increased their holdings of municipal bonds in 2020, followed by a strong increase of holdings by exchange-traded funds.
Bank holdings increased to $513 billion from $472 billion from 2019, an increase of 9%. That was among several growth trends that stood out from the Federal Reserve's flow of funds report covering the final quarter of 2020, released Thursday.
“That’s consistent with a long-term trend of banks increasing their appetite for municipals and keeping more municipals on their balance sheet,” said Michael Decker, vice president of policy and research at Bond Dealers of America. “That’s the biggest part of the answer of who is buying these bonds.”
Mutual funds increased their holdings significantly in 2020 to $893 billion from $831 billion in 2019.
“Funds and banks were the big buyers in 2020,” Decker said. “Both increased their holdings significantly.”
Exchange-traded funds, albeit small comparatively in the muni market, grew their holdings of municipal securities significantly in 2020.
In 2020, ETFs held $64.5 billion in munis compared to $49.3 billion in 2019 — a 30% increase.
“We’ve known that the muni ETF sector has been growing,” Decker said. “These numbers confirm it. It still represents a very small segment of the market, but it’s a segment that’s growing rapidly.”
The growth can be attributed to an uptick overall in the use of ETFs across the sectors. Individual investors like using it since it allows them to trade actively and get constant liquidity through trading on the stock market throughout the day.
“The ETF sector has been growing across all product areas, it’s just become a well-established investment product, not just for retail and institutional as well,” Decker said. “Munis have been relatively slow for adoption by ETFs.”
Non-U.S. investors increased their holdings of municipal securities, according to the Fed’s report. In 2020, the rest of the world held $115 billion in munis compared to $103 billion in 2019.
Patrick Luby, a municipal strategist at CreditSights, attributed that growth to a rise in taxables. The effects of the 2017 Tax Cuts and Jobs Act, caused corporate investors to have a lower tax rate, reducing the value of tax exemption, so they went to taxables, Luby said. Taxable munis then became more attractive.
“Muni yields over corporate bonds have generally not been as attractive over the last couple of years prior to the TCJA,” Luby said. “There were periods in the last calendar year when tax-exempt munis were relatively attractive versus corporates.”
