Tax-loss selling pushes record $5 billion into muni ETFs in week ended Oct. 14

Investors put a record $5 billion into municipal bond ETFs in the week ending Oct. 14, according to LSEG Lipper Global Fund Flows data cited by AdvisorHub. That topped the previous weekly record of $3.3 billion; open-ended muni mutual funds lost $3.4 billion over the same span, their largest weekly outflow since June 2022.

The report links the flows to tax-loss harvesting after September and early-October declines. Holders sell losing positions to book losses that reduce their tax bills, then buy muni ETFs to regain exposure as yields sit at their highest levels in decades, the report says. September was the worst month for muni bonds since 2008.

PIMCO, quoted in the report, notes the tax benefit is stronger for munis than for other assets: with other asset classes the tactic generally defers a tax bill, while "municipal bond investors can utilize tax-loss harvesting to potentially eliminate tax liabilities." The reason is that muni interest is exempt from federal income tax.

Trading volume offers one gauge of orderly selling. Seven days of October trading exceeded the volume of 93% of all full months between 2007 and 2021, according to Municipal Market Analytics. Wesly Pate, a senior portfolio manager at Income Research + Management, called munis a "very fluid and functioning market" that is "allowing the facilitation of a lot of these harvesting trades." He added: "We're still probably at the very early innings of the tax-dollar harvesting."

Mark Marinella, a fixed-income portfolio manager at Capital Group in Los Angeles, dates client awareness of the trade to 2022, when Federal Reserve rate increases weakened bonds and the tax offset became a visible silver lining. He said he is not seeing investors give up on munis, which have recovered over the past two weeks and are up 2% in October. Tax-equivalent yields on munis are "really high," he said, and "that's why you're not seeing people run away with negative returns."

The mutual fund outflow is part of a shift the report describes as years in the making: investors moving out of muni mutual funds and into ETFs and separately managed accounts. The report points to large, passively managed muni ETFs overseen by BlackRock Inc. and Vanguard as part of that landscape.