After a challenging 2025, high-yield municipal bonds have significantly outperformed investment-grade munis and most other fixed income asset classes in 2026. This outperformance is driven by elevated yields, favorable supply-demand technicals, and strong credit fundamentals. Current tax-equivalent yields for high-yield munis are competitive with, and often exceed, those of taxable fixed income sectors like high-yield corporates, investment-grade corporates, mortgage-backed securities, and Treasuries. Historically, high-yield munis have consistently outperformed investment-grade munis over longer investment horizons, largely due to higher coupon income which helps mitigate periods of rising interest rates and market volatility.
Despite overall municipal issuance hitting record levels in 2025 and on track for another record in 2026, high-yield muni issuance has remained constrained. Year-to-date through June 2026, high-yield muni issuance totaled only $16 billion, representing 6% of total issuance, a decrease from the 8% average between 2019 and 2025. This constrained supply, coupled with healthy fund flows from high-income investors and renewed institutional interest, has contributed to the sector's strong performance. However, demand in the broader muni market saw some shifts in July, with yields rising an average of 36 basis points and muni/US Treasury ratios cheapening.
While the macro environment for high-yield munis is compelling, it is crucial to recognize that this is an idiosyncratic asset class where returns are primarily driven by issuer-specific credit outcomes. This necessitates active, deep, bottom-up credit analysis to capture opportunities and manage risks, especially given the sector's complexity, fragmented issuer base, and significant proportion of unrated securities. Investment-grade munis offer stability and high credit quality, while high-yield munis can enhance portfolio income and long-term return potential, albeit with greater credit and liquidity risk. In July 2026, the Bloomberg Muni High Yield Index saw a decrease of 1.51%, with most high-yield sectors experiencing negative returns, except for the Electric sector which posted a positive return of 0.31%. Education and Puerto Rico sectors showed the largest negative returns, down 2.58% and 2.05%, respectively.
