Can Active Management Make a Difference With Municipal Bonds?

In broad terms, there appears to be little headline risk facing advisors and income investors mulling municipal bonds. All 50 states carry investment-grade credit ratings, confirming that their credit quality remains solid.

Those factors may imply that investors can rely on passive strategies to carry the day in the municipal bond space. Upon closer examination, though, active management may prove to be the better muni bet today. Federal funding issues confirm why that’s the case. The One Big Beautiful Bill Act (OBBBA) contains cuts to various programs, including Medicaid and the Supplemental Nutrition Assistance Program (SNAP), shifting some of the financial burden to states.

“The OBBBA reduced federal SNAP funding by $186 billion over 10 years. Changes include stricter work requirements, a 25% increase in each state’s share of administrative costs, and a requirement for states to pay up to 15% of program costs if the payment error rate exceeds 6%,” noted American Century.

Underscoring the advantages of active management with munis in today’s environment, states won’t be dealing with federal funding cuts in uniform fashion. That’s a point worth considering as the fiscal 2027 budget cycle ramps up.

OBBBA Forcing States to Make Choices

Another reason the marriage of active management and municipal bonds may benefit investors is that states are having to make some tough choices due to the aforementioned cuts include in OBBBA.

“The 2027 budget cycle finds many AAA-rated states in unfamiliar territory, facing slowing revenue growth. We aren’t currently overly concerned with any of the state actions or indicators. Nevertheless, we believe the challenges posed by persistent inflation and increasing base health care costs will require expense cuts, new revenues and increased efficiencies,” added American Century.

The asset manager sees the bulk of highly rated states being successful in balancing their budgets. How various states get there is another matter. Some, including California, are considering wealth taxes to boost revenue. Meanwhile, various counties across the U.S. are raising sales taxes in anticipation of needed revenue to make up for OBBBA cuts. Add it all up and active management could well bear fruit for muni investors.

“As various funding provisions of the OBBBA unfold, our research team is diligently monitoring responses from state and local officials. Our goal is to assess the funding solutions and identify areas of stress and pockets of opportunity,” concluded American Century.

Active municipal bond ETFs include the American Century Diversified Municipal Bond ETF (TAXF) and the American Century California Municipal Bond ETF (CATF).

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