A Quiet, Tax-Free Haven Is Braced for Change

Published Jan 30, 2025, 9:00 AM

Municipal bonds are the foundation of how American cities and states operate. And a big reason investors love “munis” is their tax-free status. But if you think that makes muni exchange-traded funds sound boring, think again.

On this episode, Eric and Joel speak with Eric Kazatsky, head of municipal strategy at Bloomberg Intelligence and co-host of the podcast Masters of the Muniverse. They discuss the storied history of munis, how they figure into portfolios—and how that favored tax-free status could be at risk in President Donald Trump’s second term.

Welcome to Trillions. I'm Joel Webber and.

I'm Eric Belchernas.

There's this theme that we've been talking about for a while, Eric, and you've been wanting to do it. I've been resisting.

So I don't know how many episodes we've done.

Maybe two hundred we should actually count.

And there's probably only like forty categories of ETFs, meaning we've covered many categories multiple times that we've never covered this one because because of me. Yeah, well, and I understand it is arguably one of the more boring sounding categories. I mean I was talking about I would put it right up around short duration bonds.

Have you done that one?

We have? Yeah, because money markets, this is municipal bonds.

Now, hold on, I'm gonna fall asleep.

Before people tune out here. Listen a couple things for of all, One of the most red analysts in Bloomberg Intelligence is Eric Kazatski, my colleague. I've known her for years and he's very colorful writer too, And people really use Muni's, especially if you're planning a portfolio for a real person. The after tax yield on these bonds is great. I remember interviewing Bogel Jack Bogel and he was a big Muni guy. He loved Muni's for his portfolio. And when I look at some of Eric Kazyski's headlines, what I like about them is they're so tangible. La Fires, Texas Battleship, JFK Airport, the Hollywood Strike, DeSantis, and Disney. There are Muni pegs to a lot of stuff that we love and know. So I think.

America is built on the municipal bonds.

It really is. It runs on Muni's basically. So we are going to try to.

Get in other words, a long overdue episode.

We're going to try to make Muni's cool today. Yeah, okay, that's our that's our time. I'm going to try to keep you awake, riveted, and Eric will too.

I'm in, I'm in. Eric has the bigger job, though, I'm so ready and joining us on this episode. Eric Kazatski an analyst with Bloomberg Intelligence who's also the co host to the podcast Masters of the Universe, this time on Trillions Muni Land. Eric, Welcome to Trillions.

Hey, I'm happy to be here, and what a setup. I wasn't sure where that was going at first, but you guys turned it around at the last minute. Thank you, Eric.

You know, as baltun is set up here. Long overdue conversation. So why do investors like municipal bonds?

I mean it's really simple. Do you like paying taxes? I don't like paying taxes?

Okay, So why are they so boring?

I think because people are confused by them. But look, at the end of the day, it's the simplest thing to understand. Right, Hey, Look, you live somewhere.

Has a school.

Undoubtedly that school was built with tax exempt bonds. You have been to a sports game lately, a concert, Undoubtedly those have been built with tax free bonds. Airports, roads, bridges. It's just the easy stuff you see every day that gets ignored the most. That's really what it comes down to.

Okay, So there's this tax exemption that munieds benefit from. How does that work and why are they exempt?

Yeah?

I mean, well, so it's been tax law for almost one hundred years. I mean, the market has been around that long. But essentially, what you do is the issuer gets a benefit to borrow at a lower rate, and that's passed on to the buyers of those bonds and they get to save the interest that comes in as income from their federal and state taxes. Now, it doesn't all work the same. Some states have different laws. But let's just assume that they're all federally in state tax free. It's just simple for this conversation. So look, it's a double benefit, right. The issuers get the benefit of borrowing lower and the investors get the tax free income. It's really as simple as that.

Real quick, Okay, let's just bring one up here. The I shares California Municipal Bond etf CMF is the ticker it. I have a yield here of two point eight percent. So what is the because when I when you talk un these people talk about after tax yield, what would be the tax equivalent yield? How much more do you get if you lived than say California.

It's so you use the role of two here, right, Just figure in these high tax dates like New York, New Jersey, California.

Just double the yield.

You'll probably get pretty close.

Because you know, the highest tax back in California, you're looking at like thirteen point three percent. You add in federal taxes Medicaid, you're up near fifty percent, So five point six percent on a taxi equivalent basis.

That's pretty cool. See that they don't put that in the data need because that's keeping you do.

Yeah, Eric, I need you for something else here, which is why is that taxes in status potentially at risk?

Well, it really comes down to the returning president. He has a mandate in his mind to roll out of the Tax Cuts and Jobs Act. And look, it's going to cost anywhere three and a half four point six trillion, I don't know, pick a number, any number, but you need a way to pay for it. And every election cycle it comes up that you know, muni bonds are going to be at risk. And I think it really comes down to the fact that people assume that those people who are buying munis are sitting around with top hats and monocles, just smoking cigars and enjoying all this tax free income. But if you look at where the money's going in muni's, I'm sure we're going to touch on this. It's going to eats, it's going to SMEs.

And these are.

Low cost, low dollar fee structures that are attracting people not in the highest brackets. So you know, that's really sort of where the risk comes in. It's going to impact everyone.

So just to be clear here, nothing is happening yet, but it's just part of the chatter about the Trump's tax cuts, which will become a conversation this year since he's back in the White House and has control of Congress and those tax cuts are expiring at the end of the year.

Right, Yes, So the Houseways and Means put out a wish list the fifty pages long, and the union exemption going away was one of the items on there. But another thing you need to know about people in munialand we'd love to be part of the current news cycle, and this is just another way for us to sort of pop in there.

Not to be boring and be part of the es. Yeah.

Yes, actually thing I tell people that all the times, Like you give me a headline, I'll show you the ETF PEG and I like that too. Eric, I, well, let's go to La fires. Explain to me the Munich connection here, because I saw you had a note that. Again, his notes do really well readership wise.

So yeah, so Los Angeles fire is just another instance of nature just wreaking havoc on our market.

You know.

Look, every year you got hurricane damage in Florida. Inevitably, it's hitting areas where you know, people are paying taxes. Those taxes support general obligation bonds, you know, hospitals, colleges, things are impacted by these weather events. And unfortunately California it really sort of got out of control with this sort of unseasonal fire that took everyone by surprise. By the numbers, we sort of calculated that there was potentially about seventy billion of you know, MUNI sort of tangentially.

Related projects at risk.

What it's actually going to shake out to too early to tell still, you know, but look, the totality of the damage would certainly call a lot of people by surprise.

And what does that mean for bondholders?

You know, hopefully nothing right. We want to be benign and in the background, and we want to sort of keep on with the you know adage that there's never been a true MUNI default from an act of God. We haven't seen one yet. I don't really think you're going to see one here. It doesn't mean there's not going to be litigation that's going to be painful, especially for LA Department of Water and Power. The Water Department is already smacked with the lawsuit. Not sure how it's going to play out, but they could have some liability.

Right when has there been defaults? What would cause one?

Well, I mean you have defaults as far as Puerto Rico, as far as Detroit, you know, and New York back in the seventies. Right, it really comes down to bad fiscal management. Bad fiscal management has caused more issues immuniland then weather and nature related events at this point.

So do you cover that, Like, do you look at where maybe the code red situations are, where there's like total mismanagement of funds. I don't know why I keep thinking of Illinois, like are they like that?

Your right to think that. Yeah, Look, we try and turn on the lights and see where the cockroaches are running as much as possible. But you know the problem is these are slow burned things, right, Detroit played out over years. It wasn't a new issue. Puerto Rico, same thing. You know, certainly Chicago, Chicago board ed, Illinois. They all have their problems. The problem is they're able to kick the can down the road.

You know.

We just try and stay on top of it and tell investors sort of where the risks are.

So let's talk about practical application. Let's say you have a munique portion of a portfolio. The two biggest ones on the market are MUB and vtebs. That's our shares in Vanguard. Those have like thirty five and forty billion dollars. They're the studs. Like most categories, it's like the two, the big two have the top ETF. So should someone just buy one of those and call it a day, or like, what does a munich analyst think of those two sort of big timers.

It's like vanilla ice cream. It's great, it's a fine flavor, it's a top seller, but like, you can only have so much of it, right, Everybody wants some variety, and that's the beauty of the ETF market is that it's bringing in a lot of alternative flavors and small boutique ice cream providers. Let's say you know, MUB and b TEP are great, right, measured by flows, they are. They're the biggest creatures, sort of like roaming around Uniland. The problem is they miss a big portion of the market. They're passive, which is not a bad thing, but they don't invest in hospitals, they don't invest in higher ed they don't invest in bonds that are subject to alternative minimum tax. We wrote a note earlier in the year they miss about eighteen percent of the investable market for unis just based on their sort of stringing criteria, and unfortunately that eighteen percent makes up a big portion of returns in every single year. So I think investor are missing out right.

I remember back I don't know five six years ago, MUB was the big category leader by far. Then Vanguard launched one started climbing the charts VTEB, and I remember MUB I think was twenty five basis points. Vanguard was like six or seven, and MUB slashed its fee in one shot from twenty five to seven. And I thought, that's why I call it the tyrodome. Jrol. You're the leader of the category, most volume, most assets, but you know what's about to happen, and you basically cut off both legs and an arm. That's it. I've never seen self cannibalization that great. But there's still number one.

It worked.

I mean, had they not done that, I think vteb's three four times bigger. So that's also something Eric. Just before we get to the unique ETFs, the MUNI mutual funds they're all active, right, There really is not a lot passive there. And here you have two ETFs at f five basis points each. How much does that factor into all the money that's rushed here, Given that most mutual funds are like, you know, eighty basis points to maybe one point five percent.

It's factored in a ton When you think about who the majority of folks are buying this thing, right, you have a lot of retail people just directly buying. But it's also part of platform investing.

Right.

So if I'm an RIA, I'm charging one percent on a portfolio, and I can go from let's say, splitting a thirty basis point fee with a mutual fund and keeping seventy to keeping ninety five and I have fives you know for investing in MUB or VTAB. That sounds much better to me, right, And my clients are probably like none the worse off as far as exposure. But I think again, two different styles, right, If you're worried about performance, you may not want to go dout on the road. If you're focusing on just acid allocation and fees, they're certainly the most attractive thing out there.

Okay, So hot sauce has come for every ETF I can think of, what does hot sauce in muni bonds look like?

So, you know, one thing that was launched very recently was Spider has target Maturity Muni bonds, So for example at Spider SSGA MY twenty twenty eight, so that's a niche version, so that that means all the bonds mature in that year. That way you can like time your duration a little bit. We've seen some other things launched like tax aware muni bonds, a lot of short duration muni bonds, high yield, I know high yield. Eric was one that back when COVID happened. Eric and I talked a lot because there was NTF HYD which is the van k hig yield muni and this thing traded it like twenty to thirty percent discounts to NAV. And of all the bond ETFs, this was the worst in terms of it obviously held the least liquid stuff that its price was deviating that much from the NAV, although the NAV was based on old bond prices, so it was stale. And it's interesting that ETF, even though it was so, it turned into a closed then fund essentially it's took in more assets since then and the volumes the same, So it seems like people know how to roll with that. But Eric, what's the liquidity like in this scene? Like, is a high old MUNI bond etf like something that's for normal people or is that something that really just traders should use. No.

I think there's a lot of liquidity, right. Look, what happened in the early days of COVID, I feel like is a complete anomaly, right, And I think the market's a lot more prepared from a market structure standpoint than it was in twenty twenty. A lot more things have changed. So let's say we had a sharp sell off again, I think the folks who are running hid if I was them, I would imagine they have a much deeper ig basket of bonds to throw over the side of the boat. If there's some sort of like sharp correction then there was back then, right, just to sort of like hedge against that. But you know, look, I think the fact that this market is really sort of like if you think about it in terms of the the you know, the fun companies are going to go to where the puck is right, and they're all skating toward high yield active, you know, sort of restructuring the old mutual funds, wrapping them in an ETF wrapper.

That really is sort of the.

Play of the day when it comes to this dimmunity space right now, and we're seeing sort of that play out, and the fact they're all crowding into the high yield space, it means that they still see an opportunity there. What's going to be interesting to see if the market responds from an issuing standpoint to sort of keep the lights on and keep the supply going to feed all these new projects.

It's interesting, Joe, one hundred and forty one billion in this category, twenty three billion active. But active makes up the majority of the number of ETF So, in other words, active is a lot of the new launches, a lot of the supply.

And we know that active has been coming for fixed income forever, so that's not surprising, maybe not forever for the past couple of years. As Hot Sauce goes, I don't think that that's very spicy, Eric.

I don't know. I mean hyd I'm not sure it gets much spicier than that. There's no leveraged Munich and this is icy as meaning land gets yeah, And I think that's part of why sometimes we don't look at it too much, like it never jumps away. That's why HYD at that time I called the Canary and the coal mine because it was trading at the deepest discount. But one thing I thought about this space, Eric, is this idea of like how to jazz it up a little, because when Eric talks about and his headlines, it gets my brain going better than when I look at the names of the ETFs. For example, how come they don't come out with hospitals and schools and because.

In my opinion, this is I'm kind of into those reality ESG the things I know.

Yeah, it's like it's like better than ESG because like I'm gonna invest in this and I literally know it's going to go to stuff that I like and want to support, versus ESG where it's like, don't you know, let's take out this stock even though it's not that bad whatever. I don't get why they don't want to play with the names focus on the tangible, yeah, and do more tangible stuff and thematic. It's weird to they haven't done much.

They're like by la, like, yeah, it seems like you could get behind that.

Yeah, help with la exactly.

I don't disagree, but you know, it's interesting. Someone probably paid a lot of money to come up with these really snazzy tickers on some of these, and unless you know exactly what they're doing, you don't get a lot one of the ones I'll point to and we talk about hot sauce. I mean, look, I disagree. I think there is leverage to be had in the UNI ets space and RTAI is a perfect example of that. Right, you know, when rates were jumping up, this is one of the worst performers.

Rates eased off a bit last year, it.

Was one of the best performers, and it's one of the most levered muni ETFs out there. One year returns almost eleven percent.

Okay, so this is just so people don't play the name of it, because I actually didn't know this one rare view tax advantage incoming to you. Yeah, that name is boring. I gotta be honest with you. And you're saying this has leverage in it. Yeah how much? What percent? Right?

I think it's up here, like thirty to thirty five percent, just sort of back of the envelope.

I'd have to double check that.

Yeah, the yield is five percent. That's pretty especially if you get an after tax yield of a little more than that.

So there is spice.

Yes, okay, Like I said, it's it's all relative, right, This is spicy for.

The ghost pepper of New Zealand.

Yes, Oh my god, let me look at the volatility here. Yeah. By the way, the volatility is still half the S and P. That's spicy over there. Yeah, it's like a kiddie ride in the equities.

Yes, okay, Eric, I want to bring this back to this threat that seems kind of existential. Like if already it's really hard to care about Muni Land for a certain investor or, at least one name Joel, and this taxes emption goes away, how how existential does that make Uni Land?

Think about it this way. You know, state and local governments still need to finance billions of dollars a year to keep the lights on right, keep things in good repair, and so if the exemption went away, it just means they're going to be borrowing in the tax will market at higher rates. I don't think they're gonna be borrowing where like Apple or Microsoft issue probably somewhere below that, but significantly more than they are now. And guess what they're passing that cost on to you. They're passing that cost on to mister balchiunis the passing it on to me, you know? And I think that's the underappreciated point here, right. We all sort of benefit from that collective subsidy that's being issued for the top hat and monocle crowd if we sort of want to go back to that analogy, but we're all sort of getting something for that as well, and it's less taxes than it could be. And I think that's sort of the point to really sort of head home with those who are making the decisions in Washington.

Man.

The lobbying, uh feels like it's going to be very allowed on this one. It's gonna it's gonna be an interesting thing to watch, especially at this moment that we've got a Magna crowd that's taken over uh, you know, the Republican wing and and you know, something like this seems like it'll be an interesting topic of cover station in the year to come. Yeah, Balchinus, any any final thoughts.

No, I just wanted to kind of ask Eric as an analyst who sees all these ETFs coming out, because sometimes he does cover the ETF side of things. Are there any sort of out of the box ETF besides RTAI that that sort of stand out to you? Is is interesting or something that that you might have designed yourself if you were initire.

You know one that sort of comes to mind, and it's selfishly, it's a shameless plug for Masters of the Universe. It's someone we had on not long ago. You know, Rockefeller Asset Management, and they have a new fund RMOP and you know what they're doing is they're getting really down the weeds on the credit side of things. So like twenty twenty one percent of their asset allocation is in charter schools, which is sort of one of the I would say most esoteric areas of community space, you know, and then there are other expert as airports. Right, So I really have a blend of this really niche credit space and then something everybody's using. And I really sort of like that approach, right, Eric.

I've got one final question for you. It's a question that we often ask on trillions at the end. What is your favorite ETF ticker?

My favorite one it has to be hid I mean, and I only say that because, look, I mean, I don't want to give them a two heart of a time, but they were woefully underprepared for COVID, and I think it really played out in real time. But you know, I think the thing is it brought so much attention to the fact that there were high yield muni tfs, and I feel like that has sort of, you know, in one way, led to the growth of all these new products coming online right now.

And let me say one thing HYD in COVID to me is the ticker I bring up all the time Joel to explain that if you put private equity were private credit in an ETF and it's like fifteen to twenty percent of the fund, that let's just say that that person is illiquid, it probably still wouldn't be trading it the discount that was. In other words, I think HYD shows that you can have people have a hybrid closed in fund ETF situation, they'd still prefer that then going to the mutual fund or interval fund. That's my theory on this and why it's okay and this will work. I use HID all the time.

Yeah, HYD had to suffer so we can have nice things today.

Yes, I like that. I may steal that for a headline.

All right, Eric Kazatski, thanks for making munis not so boring. Yeah, thanks for having me and for being a guest on Trillions. Long overdue, we'll have you back. Thanks for listening to Trillions until next time. You can find us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcasts, Spotify, or wherever else you'd like to listen. We'd love to hear from you. We're on Twitter. I'm at Joel Webbers Show. He's at Eric Baultness. This episode of Trillions was produced by Magnus Hendrickson. Bye.

This is the this is

In 1 playlist(s)

  1. Trillions

    219 clip(s)

Trillions

Money goes where it's treated best. That simple truth is a big reason why more and more money—trilli 
Social links
Follow podcast
Recent clips
Browse 218 clip(s)