Interest in prepaid gas bonds has long been reserved for mutual funds, broker-dealers and insurance companies, but new structures, growing comfort and interest in diverse credits have led to greater participation from separately managed accounts, a sign of strength for the sector, analysts said.
The prepaid gas sector, once a small niche sector in the muni market, has grown exponentially over the years, with issuance reaching a record $31.4 billion in 2025.
Some market participants expect another record year in 2026, with the sector already seeing $4.2 billion in tax-exempt issuance, according to J.P. Morgan strategists led by Peter DeGroot in Tuesday's report.
While this is down 5% year-over-year, it is up 59% compared to the trailing five-year average, they said.
Currently, the gas prepay sector's market size has topped $100 billion, accounting for 5.2% of the total benchmark index, J.P. Morgan strategists said in a January report.
Index weights vary widely by state and curve, with gas prepay bonds making up 25% of Bloomberg's California Intermediate Index, they said last month.
"That growth makes [prepaid gas] one of those sectors that's hard to ignore," said Jude Scaglione, director and head of fixed income research at A&M Private Wealth Partners.
A sector where muni SMAs — which now hold an estimated $1.3 trillion in AUM across around 180 managers, per J.P. Morgan — find value as "customization and active portfolio management identify additional yield opportunities for this expanding investor base," said Jeff Lipton, The Bond Buyer's market intelligence analyst.
Historically, SMAs were not particularly interested in the prepaid gas sector, but 2018 marked a turning point: issuance surged from $1.1 billion in 2016 to $9.5 billion that year, Scaglione said.
From there, a bit of a "dip" followed and issuance "dropped down" with COVID in 2020, he said. However, since 2021, SMA participation has increased year-over-year as the buyer base expanded significantly, Scaglione said.
For example, Sage Advisory, an investment management firm focused solely on SMAs, started "picking up" some prepaid gas bond exposure after the 2023 banking crisis-induced spread widening led to attractive valuations, Jeff Timlin, managing partner and head of municipal bond investing at the firm, told The Bond Buyer in April 2024.
"Since then, the attractive valuations and the outperformance those particular bonds have … caught the attention of many SMA players in the market," he said at the time.
Currently, the firm is overweight in prepaid gas, believing the sector is among the most attractive in the market, Timlin said in a February interview.
"We have some pretty broad exposure in all prepaid gas issuers and backers, so if we don't participate, it's not for lack of interest; it's because we probably already own the name," he said.
Some market participants, however, remain wary of the sector, despite SMA's growing presence.
"Because the prepay energy market isn't mainstream, muni SMA managers often avoid its unfamiliar, intricate structure," AllianceBernstein strategists said, noting not all investors are "equipped to navigate these securities."
"The issue isn't fundamental weakness — it's a lack of understanding of the sectors' complexity, which is riddled with mispricing and information gaps, which can create opportunities for those who know where to look," they said.
Furthermore, not all SMAs are created equal, and investment guidelines and suitability requirements have to be considered, Lipton said.
Gas prepay bonds "are not secured by municipalities even though the off-taker of the commodity is a municipality or municipal authority," he said.
Bond ratings are linked to the ultimate guarantor of the cash flows underlying the deal, even when other transaction counterparties experience cash-flow failures. These structures are specifically designed to tie those cash flows back to the guarantor, Lipton said.
This structure "exposes" the bonds to corporate credit risk and so it is important to consider individual SMA account suitability, risk tolerance and portfolio constraints, he said, noting portfolio managers may impose account-level restrictions with respect to gas-prepay investments.
While the bonds will be subject to risk associated with the borrower and guarantor, the overall market risk is more manageable, Timlin said.
There could be a little bit more spread volatility, but "you're getting a substantial amount of increase in spread over anything in that universe that's similarly rated, even across any sector," he said.
Liquidity is not an issue as prepaid gas bonds are among the most liquid bonds in the muni market, as they come in such "large denominations," while credit risk is on par with where the sector should be, Timlin added.
Even with these potential risks, interest in prepaid gas bonds from SMA buyers — who, in the past, like those aforementioned, were uncomfortable with the sector — is the "natural progression of finding value," said Chad Farrington, co-head of municipal bond investment strategy at DWS.
As of the third quarter of 2025, the majority of gas prepay bonds are held by open-end mutual funds (around $63 billion or 67% of the total market), J.P. Morgan strategists said, citing IPREO holding data.
While nearly one-quarter (around $23 billion) of these bonds are held primarily by SMAs and are "in retail hands," J.P. Morgan strategists noted SMA ownership of gas prepay should continue to grow.
"It's something that you haven't historically bought [but] you have to get comfortable with it … because there's just nowhere else to go," DWS' Farrington said.
After all, "where else can you find some yield, 120 spread, or whatever it is for single-A credit? You don't find that anywhere else," he said.
And as more market participants become comfortable with the prepaid gas sector, issuers are structuring their deals to better serve this evolving buyer base, said Kyle Gerberding, director of trading, a portfolio manager and partner at Asset Preservation Advisors.
The deals have shifted from two or three terms with a mandatory put or soft put to serials, like a typical muni structure, which brings in a new "batch of buyers," he said.
"Underwriters are starting to create language in the documentation that doesn't necessarily read like a hard put. The hard put in the structure will read with a final maturity of, call it, 2056, if you're doing a 30-year or whatever it may be, whereas, from a reporting requirement, the language they have is like an extendable maturity. So it would be kind of a five-, seven- and 10-year maturity range, which falls more in the sweet spot with SMAs," A&M's Scaglione said.
"Now that SMAs are becoming a significant part of demand, these prepaid deals need SMAs to be able to clear the market easily," Ben Barber, director of municipal bonds at Franklin Templeton, said in a December interview.
Therefore, this shift "to doing just final maturities in seven years, 10 years … [may not be] the best thing for the issuer, but if it means a 30-, 40-, 50-basis point spread, that's what they'll do," he said.
"We'll likely see a shift to that because [issuers] have to figure out demand that will be attractive to SMAs," Barber said.
