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Munis can help hedge against equity sell-offs

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      By Michael J. Sullivan, CFA, Institutional Portfolio Manager, Eaton Vance

      Boston - For investors worried about stock drop-offs, municipal bonds — which correlate negatively with equities — can help to diversify portfolios, protect against volatility, and weather stock sell-offs.

      The chart below shows the five largest equity drops since January 2009 compared with muni bond gains during the same periods.

      Top 5 Sell Offs

      In these five drawdowns, as the stock index plummeted an average of 19.39%, the Bloomberg Barclays index returned 3.47% on average. Stocks dropped 5% in a month once during each drawdown; since 2009, muni bonds haven't dropped that much once.

      Munis are also attractive relative to other bonds. They bring advantages for high-tax-bracket investors because they are exempt from federal — and sometimes state and local — taxes. They are also relatively rich to US Treasuries. The yield ratio of AAA 10-year munis to Treasuries is 73%, which trails recent averages but isn't without historical precedent. These valuations may be sustainable, partially because the SALT deduction cap has significantly affected bond demand.

      Bottom line: Investors seeking tax-advantaged instruments to diversify equity-heavy portfolios should give muni bonds a close look.

      Income may be subject to state and local taxes and potentially the AMT.

      The Bloomberg Barclays Municipal Bond Index is an unmanaged index of taxable municipal bonds traded in the U.S.