The Federal Reserve’s recent rate cut of 25 basis points didn’t come as a surprise to the majority of the capital markets. However, it did leave the door of uncertainty open for just how aggressive or conservative the central bank will be with monetary policy moving forward. The prospect of aggressive cuts could make fixed income investors nervous when it comes to yield, but one option they may not have considered is high yield municipal bonds.
Right now, the markets are bracing themselves for a more dovish Fed who recently forecasted that only one rate cut will occur in 2026. This projection runs counter to those hoping for more aggressive cuts, but that could all change if economic data supports more easing.
“Next year’s dot plot is a mosaic of different perspectives and is an accurate reflection of a confusing economic outlook, muddied by labor supply shifts, data measurement concerns and government policy upheaval and uncertainty,” said Seema Shah, chief global strategist at Principal Asset Management.
Because of this uncertainty, it warrants an active approach. That is certainly the case when it comes to municipal bonds, which carry their own unique complexities. The need for active is even more imperative when it comes to high yield munis.
An Active Approach
Because of the uncertainty and the unique characteristics of high yield munis, getting exposure with an active fund like the Invesco Rochester High Yield Municipal ETF (IROC) is an ideal choice. For those fixated on yield, it comes with a 30-day SEC yield of 4.69% and a 12-month distribution rate of 4.43% as of September 18.
Fixed income investors looking to turn up the wick on yield in exchange for accepting a higher degree of credit risk may appreciate munis versus corporate bonds. The risk premium could present a better alternative for investors who are seeking options in the high yield corporate bond market. Furthermore, they get the added benefit of munis since their income is devoid of federal income tax, unlike their corporate counterparts. With interest rates still relatively high, this could be a concern for debt servicing costs in corporate bonds, which can eat into a company’s revenue.
As mentioned, the active management component is a must in a high yield muni space that exhibits unique market characteristics. In the case of IROC, the active strategy allows the portfolio managers to adjust the fund’s holdings to better correlate with current market conditions to capture upside or mitigate downside risk.
The fund seeks to maintain a duration of less than 7.5 years and carries a competitive expense ratio of 39 basis points.
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