The truth is actually a lot less exciting.
It’s well documented that high-net worth individuals (HNWIs), in many respects, tend to be more practical in their spending habits than most folks. They appreciate a good deal, and they’re finely attuned to saving money where they can—one of the biggest contributors to how they got where they are.
“What are the three words that profile the affluent?” ask Thomas Stanley and Willian Danko in their bestseller The Millionaire Next Door: The Surprising Secrets of America’s Wealthy. The answer? “FRUGAL FRUGAL FRUGAL.”
This penny-pinching attitude extends to their investment decisions.
So if they’re not investing in Picassos and Renoirs, or $20,000 bottles of Romanée-Conti, what are they investing in?
That’s the finding of Rick Fleming, the SEC’s top investor advocate, charged with analyzing how regulations might impact investors and their investments. Muni bond income, after all, is entirely exempt from federal and often state and local taxes—a feature that should appeal not just to money-saving HNWIs but to all investors.
Avoiding Income Tax with Tax-Free Municipal Bonds
At an SEC summit held August 25, Fleming revealed some statistics he finds both “interesting” and “disturbing.”
“The wealthiest one-half percent of U.S. households,” Fleming said, “now own 42 percent of all municipal bonds, as compared to ownership of 24 percent in 1989.”
Meanwhile, “The bottom 90 percent of U.S. households, as measured by net wealth, now hold less than 5 percent of muni bonds, falling from almost 15 percent in 1989.”
Let’s do the math. The muni market is currently valued at $3.71 trillion. Using Fleming’s data, that means a very small percentage of muni investors holds around $1.5 trillion—a vast sum of money for so few people. On the flip side, a great number of people—nearly all muni investors, in fact—collectively hold “only” $185 billion worth of muni debt.
This is indeed disturbing.
Muni bonds’ favorable tax exemption was created a little over 100 years ago to attract investors of all stripes, not just those at the very top of the socioeconomic ladder, to help boost infrastructure spending. Although HNWIs have historically been more drawn to munis than investors in lower tax brackets, the spread has widened alarmingly in recent years.
Fleming sees this as a problem, and you should too. I always say to follow the smart money, and in the case of municipal bonds, it’s clear the smart money has spoken.
HNWIs are unfazed by the perception that munis are “boring” or “plain vanilla.” They don’t care about that. What they do care about is a reliable, tax-free income stream, not to mention a history of stability in times of economic and political uncertainty—both of which munis can deliver.
No Loss of Momentum
To be clear, muni investment is not in decline. Quite the contrary. There’s a clear uptrend in the amount of money that’s flowing into muni bond funds on a weekly basis, fueled by not just the appetite for tax-free income but also a need to preserve capital. For the 48th straight week as of August 31, muni bond funds, excluding ETFs, attracted net new money—a spectacular run, according to Investment Company Institute (ICI) data.
Meanwhile, capital continues to leave domestic equity funds as investors de-risk in the face of global macroeconomic uncertainty and the possibility of rising interest rates in the U.S. this year.
What I find most interesting is that, although investors are increasingly moving capital from actively-managed equity funds to ETFs, they still prefer actively-managed muni bond funds. For the 12-month period ended in July, active muni funds collected $48.7 billion. That’s eight times more than what passive funds brought in over the same period, according to a recent Bloomberg story.
In this case, I think what muni investors seek is a manager who knows how to conduct deep credit research, adjust for duration and monitor the market for risks and opportunities. That appears to be investors’ demand, whether they’re in the top 1 percent or not.
Editor’s note: ETF investors seeking municipal bond exposure can consider the iShares National Muni Bond ETF (NYSE:MUB). With over $7.6 billion in assets under management and a reasonable expense ratio of 0.25%, MUB has proven to be a very popular option for yield-seeking investors in the current low interest rate environment.
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About the Author: Frank Holmes
Frank Holmes is the CEO and chief investment officer of U.S. Global Investors. Mr. Holmes purchased a controlling interest in U.S. Global Investors in 1989 and became the firm’s chief investment officer in 1999. In 2006, Mr. Holmes was selected mining fund manager of the year by the Mining Journal, and in 2011 he was named a U.S. Metals and Mining “TopGun” by Brendan Wood International. He is also the co-author of The Goldwatcher: Demystifying Gold Investing. More than 30,000 subscribers follow his weekly commentary in the award-winning Investor Alert newsletter which is read in over 180 countries.
Under his guidance, the company’s mutual funds have received recognition from Lipper and Morningstar, two trusted independent financial authorities. In 2015, Mr. Holmes led the company into the exchange traded fund (ETF) business with the launch of the U.S. Global Jets ETF, which invests in the global airline sector.