Active Muni-Bond Funds for the Core of Your Portfolio

Morningstar’s Guide to Active Fixed-Income Investing lays out the case for active bond funds. In short, the complexity and inefficiencies of the bond market spell opportunity for skilled portfolio managers.

While most investors focus on taxable bonds, the argument for active investing applies to the municipal-bond market as well. In “How to Use Municipal-Bond Funds in a Portfolio,” Amy Arnott and Margaret Giles provide a primer on the asset class, part of Morningstar’s portfolio basics series. Muni bonds are issued by state or local governments to raise money for day-to-day operations and public projects. The interest paid on these bonds is usually exempt from federal income taxes and may also be exempt from state and local taxes for investors who live in the state or municipality where the bond was issued.

Investors, particularly those in higher tax brackets, can therefore benefit from holding municipal-bond funds in their taxable accounts. Strategies in the muni national intermediate Morningstar Category are appropriate holdings for a core portfolio, as Morningstar’s Role in Portfolio framework explains. To home in on worthwhile actively managed offerings, the Morningstar Medalist Rating is a good place to start, as it identifies funds that are likely to outperform over a market cycle.

The list below features active mutual funds and exchange-traded funds in the muni national intermediate category that earn Gold, Silver, or Bronze ratings from our analysts. All of these strategies are rated High or Above Average on the Parent, People, and Process pillars that underlie the Medalist Rating. They also have modest expense ratios, so they have a relatively low hurdle to clear in the competition against low-cost index funds.

Because expenses affect a fund’s likelihood of outperformance, the Medalist Rating is assigned to mutual funds by share class, meaning cheaper share classes may have higher ratings than pricier share classes. The list below singles out the lowest-cost share class for each fund. Some of the cheapest share classes may be aimed at institutional investors who can meet high investment minimums, while others are available to individual investors through retirement or 529 plans. The two ETFs on the list are widely accessible to most investors. For the most recent data and analysis on a fund, click on its ticker.

How to Find More Great Funds

To maximize the tax advantages of municipal bonds, investors in high-tax states such as California and New York may want to look beyond this list to funds that focus on bonds exempt from state taxes as well. Here are ways to use Morningstar data and research to conduct your own search:

• Use the Morningstar Investor screener to create your own list of funds to investigate further.
• Explore funds on our Best Investments page.
• Read our latest insights on funds and ETFs.

This How-To article spells out how to approach a search for active bond funds in particular Morningstar Categories, using the tools available to Morningstar.com subscribers.