Investing in Municipals: A Comprehensive Overview

Investing in municipals can be a smart move for those looking for stable returns with tax benefits. Municipals are bonds issued by local governments and other public entities to finance various projects.

These bonds are generally considered to be low-risk investments, which is why they're often attractive to investors seeking stable returns. The interest earned on municipal bonds is also typically exempt from federal income tax, making them an attractive option for those in higher tax brackets.

Investors can purchase municipal bonds directly from the issuer or through a broker. The minimum investment requirements vary depending on the issuer and the type of bond.

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Municipal bonds are a type of investment product issued by local governments to finance public projects.

They can be structured in various ways, such as through government investment products.

Municipal bonds are not backed by the federal government, but rather by the creditworthiness of the issuing municipality.

Understanding the credit risk of municipal bonds is crucial, as it can impact the bond's value and potential returns.

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PGIM Fixed Income's municipal bond investment process involves three key steps. The first step is to develop a top-down investment and credit outlook, which is formulated by the senior investment management team every quarter. This outlook assesses economic, interest rate, and fixed income sector scenarios for the coming quarter.

The team uses this outlook to help evaluate the appropriate levels and types of risk to assume across municipal bond portfolios. The outlook also influences the portfolio's sector exposures and credit bias.

The senior portfolio manager and the municipal bond team then construct the portfolio, seeking to achieve excess return through establishing risk exposures in sector allocations and other portfolio characteristics that reflect the current outlook while remaining within the Strategy's pre-established risk budget.

For another approach, see: Municipal Credit Union

PGIM Fixed Income's Municipal Bond Strategies focus on revenue vs. general obligation credits. This approach allows for a more targeted investment focus.

Each strategy emphasizes a slightly different segment of the municipal bond market. This means investors have options to choose from based on their individual needs and goals.

Greater allocations are made to select ratings or duration buckets within each strategy. This adds an extra layer of diversification and risk management.

A focus on revenue credits means the strategies prioritize bonds backed by specific revenue streams. This can provide a more stable source of income for investors.

PGIM Fixed Income's investment process is a structured approach to municipal bond investing. It's a three-step process that helps achieve excess return while managing risk.

The first step is developing a top-down investment and credit outlook. Each quarter, the senior investment management team creates a Quarterly Market Outlook that assesses economic, interest rate, and fixed income sector scenarios for the coming quarter.

This Outlook plays a central role in guiding the senior portfolio manager and team in evaluating the appropriate levels and types of risk to assume. It also influences sector exposures and credit bias in municipal bond portfolios.

The team then constructs the portfolio, seeking to achieve excess return through establishing risk exposures in sector allocations and other portfolio characteristics that reflect the current Outlook.

Portfolio construction also reflects individual client guidelines and constraints, such as risk budget and allowable tracking error. The team seeks to select securities that offer attractive relative value and combine them to achieve the desired characteristics and risk profile of the portfolio.

The analysts' research and opinions are key components in identifying attractive relative value opportunities, thanks to their daily presence in the municipal bond market and relationships with broker/dealers.

Portfolio monitoring and risk management are done continuously throughout each day, with an internal Investment Risk Management and Quantitative Research Team quantifying and evaluating major risks in client portfolios.

Municipal bonds are categorized based on the source of their interest payments and principal repayments. A general obligation bond (GO) is issued by governmental entities and not backed by revenue from a specific project, such as a toll road. Some GO bonds are backed by dedicated property taxes; others are payable from general funds.

There are two main types of municipal bonds: General Obligation (GO) bonds and Revenue bonds. GO bonds are backed by the full faith and credit of the issuer, while Revenue bonds are backed by specific revenues generated by the issuer, such as tolls or water bills.

Here's a breakdown of the two main types of municipal bonds:

Municipal bonds come in various types, each with its own characteristics and benefits.

A fixed-rate bond is the most common type of municipal bond, paying a fixed rate of interest until maturity or earlier redemption.

General Obligation (GO) Bonds are backed by the "full faith and credit" of the issuer, giving them the power to tax residents to pay bondholders.

Revenue Bonds, on the other hand, are backed by revenues from specific projects, such as toll roads or bridges, airports, electric and water utilities, public or private colleges, and hospitals.

Variable Rate Demand Obligations (VRDOs) are a type of bond that pays interest based on a variable rate, with short-term interest rate periods that are reset periodically.

Here's a breakdown of the main types of municipal bonds:

Revenue Bonds can be further divided into two subcategories: Private Activity Bonds and Conduit Issuer Bonds.

For another approach, see: Green Municipal Bonds

Private Activity bonds are tax-exempt revenue bonds that finance non-governmental activities with a substantial public purpose. They're often issued by public development corporations to facilitate economic and industrial development, increase employment, and finance housing.

In Washington State, these bonds can only be issued by authorized governmental entities. This means a private business developing a project typically works with a state or local bond issuer.

The bond issuer then applies to the Department of Commerce for authorization to issue the bond. Commerce takes applications, evaluates projects, and ensures the state doesn't exceed its cap authority permitted under federal law.

Private Activity bonds are often used to finance activities or projects that satisfy a substantial public purpose, such as economic and industrial development, and increasing employment.

Tax Status is a crucial aspect of municipal bonds that can save you money on taxes. The interest earned on municipal bonds is generally excluded from gross income for federal income tax purposes.

Not all municipal bonds are tax-exempt, however. To be exempt from federal income taxes, the issuer must meet specific requirements in the federal income tax code. This typically involves investing in bonds issued by a local government or a public entity in your state.

If you're a resident of the state where the bond was issued, you may also be exempt from state and local taxes. But there are exceptions to this rule, so it's essential to check the specific tax laws in your area.

Some municipal bonds are actually taxable, such as private activity bonds, which are subject to the federal alternative minimum tax (AMT). This means that your interest income could be included in the calculation of your AMT, and the yields on these bonds are typically higher to reflect this risk.

Here are some key facts about tax status and municipal bonds: