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Tax Reform Outweighs Tax Season Tailwind for Muni Bond ETFs

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Apr 17 is the Tax Day for this year. Like every year, Americans must have looked for ways to lower their tax burden ahead of this day. Will muni bond ETFs – excellent choices for investors seeking a steady stream of tax free income — cash in on investors’ this need in 2018? Let’s take a look.

Tax Reform Versus Tax Reason

Usually, the interest income from munis is exempt from federal tax and may also not be taxable per state laws, making these especially attractive to investors in the high tax bracket looking to reduce their tax liability.

However, 2018 is different with the tax reform being passed in late December. The final version agrees to “give corporations a massive permanent tax break, temporarily cuts rates for individuals, and repeals the Affordable Care Act’s individual mandate — a move that is estimated to leave 13 million fewer insured in the next 10 years.”

The final version also cuts “the corporate rate from 35% to 21%, gives pass-through businesses like the Trump Organization a 20% tax deduction, raises the standard deduction, expands the child tax credit, and temporarily lowers individual rates across the board (read: Tax Bill: What ETF Investors Need to Know).”

Plus, Trump had proposed to increase infrastructure spending. If this happens, munis will be forced to issue more bonds offering higher yields amid lowering demand. As a result, the fervor for muni bond investing backtracked after Trump’s win in November. If these were not enough, the ongoing Fed policy tightening is yet another negative for the overall bond funds.

One-Month Scorecard of Muni ETFs

In the last four weeks (as of Apr 16, 2018), muni bond ETFs delivered moderate-to -low gains. VanEck Vectors AMT-Free Long Municipal Index ETF (MLN - Free Report) tracks the overall performance of the U.S. dollar denominated long-term tax-exempt bond market with an upper medium credit quality. It yields about 3.01% and added about 1.6% in the last one month (as of Apr 16, 2018).

Deutsche X-trackers Municipal Infrastructure Revenue Bond Fund (RVNU - Free Report) , which yields about 2.6%, added about 0.9% in last one month against 1.5% gains in iShares 20+ Year Treasury Bond ETF (TLT - Free Report) (which yields about 2.56%).

PowerShares National AMT-Free Municipal Bond Portfolio (PZA - Free Report) – which tracks the U.S. dollar-denominated, investment grade, tax-exempt debt publicly issued by U.S. states and territories or their political subdivisions, in the domestic market with a term of at least 15 years remaining to final maturity – advanced 0.6% in the last one month. It yields about 2.88% annually.

Bottom Line

In the last one month (as of Apr 16, 2018), treasury yields were subdued thanks to geopolitical risks and trade tensions between China and the United States. From this point of view, performance of muni bond ETFs should have been better this year.

But we have seen most muni bond ETFs delivering minuscule or negative returns in the last four weeks. Returns of the top-performing bond ETFs have also been lower than what we saw last year. Surely, tax reform is taking the sheen out of muni bond ETFs slowly. We have a Zacks Rank #4 (Sell) on most muni bond ETFs (read: 4 Reasons Why Muni Bond ETFs Are Back in Favor).

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