Don’t Fall off the Muni Ladder: Enhancing Your Municipal Bond SMA

In our collaboration with investment advisors we are witnessing increased demand for customized municipal bond ladders in separately managed accounts (SMAs). Thanks to technological advancements, these strategies are now accessible to a broader range of retail investors, with some account minimums as low as $100,000.  

While municipal bond ladders offer several advantages, it is important to understand both their benefits and potential drawbacks. By recent estimates, retail investors (households) directly own 45% of all municipal bonds (not including mutual funds/exchange-traded funds (ETFs)).¹ The lack of institutional quality research makes municipal bonds particularly exposed to periods of higher volatility and dislocation from underlying credit fundamentals versus the institutionally dominated Treasury and Corporate bond market.

To mitigate the inherent risk of SMA ladders, optimize returns and add optionality as conditions change, consider complementing your ladder with an actively managed intermediate municipal bond ETF.

Key Benefits of Municipal Bond Ladders

1. Predictable Tax-Free Cash Flow — Ladders can be structured to meet income needs across various time horizons:
   • Short Term (typically 1-5 years)
   • Intermediate Term (typically 1-10 years)
   • Longer Term (typically out to 30 years)
2. State-Specific Focus — High-income tax state residents (e.g. NY, NJ) can choose to concentrate the portfolio with more in-state bonds for additional tax benefits.
   
   
3. Potential Interest Rate Risk Reduction — A mix of bond maturities, spread out in rungs along the ladder, can help smooth out principal volatility as interest rates fluctuate.

Risks to Consider

Despite these benefits, municipal bond ladders come with inherent risks due to their static “set it and forget it” approach and significant direct-retail ownership characteristics:

1. Credit Risk — While most municipal SMAs are of high investment grade quality, they are typically less diversified than an average bond fund, exposing investors to idiosyncratic event and credit risks.
   
   
2. Liquidity Risk — The retail-dominated municipal bond market can experience sudden sell-offs, making it difficult to get good bids for bonds during a market panic.
   
   
3. Reinvestment Rate Risk — The ability to respond to yield curve changes and market events is more limited in a ladder structure.

Enhancing Your Strategy: The Active ETF Ballast

To help mitigate these risks while maintaining the benefits of a customized bond ladder, consider incorporating an actively managed intermediate-term municipal bond ETF.  

1. Flexibility/Liquidity — Intermediate ETFs can invest along the yield curve where value exists but still maintain duration in a relatively tight range (typically four to six years).
   
   
2. Monthly Income — These ETFs typically offer monthly dividend payments, smoothing out the income stream compared to the potentially lumpy semi-annual bond payments inherent in many ladders.  
   
   
3. Potentially Higher Income — Actively managed municipal bond ETFs may yield more than the typical high-quality SMA after fees, due to their broader market scope and ability to analyze and invest in various structures.
   
   
4. Optionality — With daily liquidity in the ETF format, investors can quickly and more cheaply enter/exit the market and adjust asset allocation.
   
   
5. Market Dislocation Opportunities — Value-based strategies can capitalize on retail market panics. They tend to be net buyers when valuations diverge from underlying fundamentals.

Conclusion

Incorporating today’s relatively attractive municipal bond rates within a managed account using a bond ladder can be a sound strategy for a wide range of investors. By complementing this approach with an actively managed ETF an investor can potentially enhance the portfolio’s resilience, liquidity and yield prospects. This balanced approach aims to provide the best of both worlds: the customization and predictability of a ladder with the flexibility and risk management of active fund management.

Important Disclosures & Definitions

1 Board of Governors of the Federal Reserve System. (December 12, 2024). Z.1 Financial Accounts of the United States: Flow of Funds, Balance Sheets, and Integrated Macroeconomic Accounts, Third Quarter 2024. Federal Reserve Statistical Release.

Investment Grade (IG): a rating that signifies that a municipal or corporate bond presents a relatively low risk of default. To be considered an investment grade issue, the company must be rated at 'BBB' or higher by Standard and Poor's or Moody's. Anything below this 'BBB' rating is considered non-investment grade.

Municipal Bond: a debt security issued by a state, municipality, or county to finance its capital expenditures, including the construction of highways, bridges, or schools. They can be thought of as loans that investors make to local governments. Municipal bonds are often exempt from federal taxes and most state and local taxes (for residents), making them especially attractive to people in higher income tax brackets.

Yield Curve: a graphical representation of the yields (y-axis) on debt instruments with different maturities (x-axis).

AAI000893  03/04/2026