Historically, municipal bond ownership has largely been limited to ultra-wealthy investors: It takes significant assets to build a diversified portfolio of muni bonds, and investing in them requires a high level of expertise and management between brokers and clients. But the launch of exchange-traded funds (ETFs) holding an assortment of muni bonds has created an attractive option for investors, combining the tax-exempt fixed income of municipal bonds with the lower fees and diversification benefits of ETFs. It has been 15 years since the launch of muni bond ETFs, but a few factors are paving the way for exponential growth in the coming years.
Morgan Stanley Research expects the value of muni ETFs to double to $200 billion in assets under management by 2026, representing about one-third of the time it took for this asset class to reach $100 billion. While this may seem like a drop in the large bucket of the $4 trillion municipal bond market, the growth of investment in muni bonds via ETFs could have an outsized impact on the market for these assets as a whole by expanding the opportunity for more investors to reap tax benefits.
"ETFs may democratize municipal ownership, increasing the percentage of households that can claim tax-exempt interest" on their income from munis, says Mark T. Schmidt, head of Municipal Strategy at Morgan Stanley Research. “Asset managers should prepare sooner rather than later and lay the framework today for effective product distribution to both retail and institutional client channels."
Setting the Stage for the Next Phase
Almost all classes of ETFs have benefitted from a recent influx of cash, with 85% reporting net inflows since the end of 2020, and muni ETFs are no different. Total assets in muni ETFs have grown by $38 billion since 2020; in 2022 alone, muni ETFs took in nearly $30 billion to account for about 11% of muni fund assets under management. “The funds’ growth could follow the trajectory of equity ETFs, which went from 11% market share in 2008 to account for 32% of equity fund assets under management presently, with an annual compound growth rate of 19%,” says Michael Cyprys head of the Brokers, Asset Managers & Exchanges team at Morgan Stanley Research.