Investors looking to retire in a decade or two wish they could still bank on 8% annual returns on their portfolios.
Chris Mier, managing director of Loop Capital Markets, believes they still can.
Investors can gain stock-like annual returns with far less risk and volatility by buying long-term municipal bonds at yields flirting with 6%, Mier said.
“The current levels of munis add tremendous power now in a way that they didn’t before,” he said. “Because of the structure of yields right now, you can actually substitute munis for equity and still meet your retirement goals. ... You can get pretty close to your modeled equity return with today’s level of muni bonds.”
The turmoil in financial markets has torpedoed some of the assumptions traditionally underpinning portfolio management, said Mier, a 52-year-old native of St. Louis.
Mier, a CFA charterholder, said until last year an investor looking toward retirement might put half his money in stocks and half in bonds. He might assume 9% annual returns on stocks and 4.5% returns on munis, and expect annual pretax returns of around 6.75%, he said.
Now, the paradigm has shifted. Tax rates are likely to go up; Mier said a 25% capital gains and qualified dividend rate is a reasonable assumption, compared with 15% now.
Add to that an awful year and a half for stocks and dismal prospects for corporate profits, and tax-exempt state and local government debt seems like a wiser centerpiece for the portfolio, he said.
According to Municipal Market Data, single-A 30-year munis yield 5.87%. Assuming a 28% tax bracket, that translates to an 8.2% tax-equivalent yield.
The result is investors can increase their expected returns with “vastly less volatility” by allocating more of their portfolios to munis.
By buying long-term munis, Mier said investors can lock in that yield and enjoy fat returns for decades without having to worry about credit risk.
Out of 14,775 single-A rated general obligation issuers from 1970 to 2000, not one defaulted, according to Moody’s Investors Service.
“It’s a conservative way of building a portfolio for retirement,” said Mier, who joined Loop Capital in May 2000. Before that, he worked at MFS Investment Management, Scudder Kemper Investments, and Comerica Bank.
Low inflation is another reason to favor munis, he said. The “real” rate of return on a bond is its yield minus the rate of inflation. With consumer prices creeping up at a rate well under 1% and some economists worrying about deflation, the real return on municipals is its highest in decades.
In fact, the difference of the 20-year muni yield and the consumer price index is more than two standard deviations away from the average spread, Mier said.
Mier likes long-term A-rated munis. The yield on 30-year A-rated paper is a full percentage point higher than the yield on 30-year triple-A paper, according to MMD. That is more than three times higher than the average spread since 2000.
The comparison with the 30-year Treasury is even starker. The single-A 30-year muni yields 217 basis points more than the comparable Treasury. A year and a half ago, the single-A yielded less than Treasuries.
Mier also likes long-term bonds, to take advantage of a steep yield curve. The 30-year single-A yields 395 basis points more than the one-year. Two years ago, the spread was at less than 60 basis points.
As an example of a solid credit offering plump returns, Mier cited Wisconsin’s appropriation-backed issue last week. Bonds from that deal maturing in 2037 yield 5.87%.