Q: Municipal Bonds ("Munis") look attractive right now—do I get much more tax-equivalent yield for the risk by stretching into private credit (direct lending)?
— Wirehouse advisor, Texas
A: In our view, there are three potential angles to look at this question. And it may be that munis and private credit are better when barbelled together!
1. Yield: If we use the S&P Municipal Bond Index, which includes short-duration, intermediate-term, and high-yield munis, the tax-equivalent yield is 7.1% compared to 12.1% for private credit—in our view, a meaningful pickup.1
Yield comparison
Combined in a 50/50 blend, munis and private credit provide an attractive 9.6% tax-equivalent yield.
2. Historical returns: Here, private credit wins, in our opinion. Going back as far as we have good data, private credit has typically outperformed municipal bonds. Private credit’s worst annual return was -6.5% vs. muni’s -5.1%, so even in stress periods, munis failed to outperform meaningfully.
Calendar-year return comparison
| Calendar-Year | Private Credit | Muni Bonds |
|---|---|---|
| 2005 | 10.1% | 4.2% |
| 2006 | 13.7% | 5.3% |
| 2007 | 10.2% | 2.8% |
| 2008 | -6.5% | -5.1% |
| 2009 | 13.2% | 14.6% |
| 2010 | 15.8% | 2.4% |
| 2011 | 9.8% | 10.6% |
| 2012 | 14.0% | 7.4% |
| 2013 | 12.7% | -2.5% |
| 2014 | 9.6% | 9.3% |
| 2015 | 5.5% | 3.3% |
| 2016 | 11.2% | 0.8% |
| 2017 | 8.6% | 4.9% |
| 2018 | 8.1% | 1.4% |
| 2019 | 9.0% | 7.3% |
| 2020 | 5.5% | 5.0% |
| 2021 | 12.8% | 1.8% |
| 2022 | 6.3% | -8.0% |
| 2023 | 12.1% | 6.0% |
3. Diversification: Because direct lending private credit is floating rate, resetting quarterly, its average three-month duration can help bring down the duration when blended into a municipal bond portfolio. Lower duration means less interest rate sensitivity for investors disinclined to forecasting future interest rate movements and policy.
Duration comparison
Credit risk is typically considered lower in a broad basket of munis versus private credit. Historically, municipal bonds have experienced lower default rates than private credit.
Finally, because private credit and munis have traditionally exhibited low correlation—0.21 since September 2004 through December 2023—blending the two in a 50/50 mix has made for a lower overall volatility than investing in either asset class alone.2
| Private Credit | Munis | 50/50 combined | |
|---|---|---|---|
| Return | 9.3% | 3.6% | 6.5% |
| Volatility | 3.5% | 4.4% | 3.1% |
| Sharpe Ratio | 2.12 | 0.37 | 1.43 |
In our view, creating a barbell approach of blending private credit with municipal bonds is a wonderfully complementary way to take the best from both public fixed-income and private markets, and we think using them together is an excellent strategic approach.
