Have muni bonds, the darlings of income-seeking investors these last couple of years, gone to the dogs?  Following returns of 6.78 percent in 2012 and 10.7 percent in 2011, they’re now the cheapest they’ve been in the last two years, and the headlines show why: From QE tapering to rising rates to municipal bankruptcies, the asset class has been battling a bad rap. So now is the time to get your clients out of munis, right?

The reality is, there are still many reasons to remain in munis or even increase your allocation. And it’s not just about buying (or dollar-cost-averaging in) at a market low. We believe improving economic fundamentals, strong performance in key sectors and the appearance of a rarely seen mispricing are all good reasons to keep giving this important asset class a closer look.

Let’s start with the basics: The fiscal condition of municipalities is generally on the upswing.

California, for instance, used to compete with Illinois for the most fiscally challenged state  in the country. This year, all three rating agencies upgraded the state following a series of painful state tax increases and spending cuts. Its legislature is now vigorously debating how to spend a budget surplus. New York State, with an AA rating, also appears  to be in good shape. Despite the state facing a tough economy, Moody’s revised its outlook for New York to positive from stable earlier this year, a move that often precedes improvements to bond ratings.

The fiscal issues of Detroit and Puerto Rico are real, and concerning.  But these are isolated cases. Good news stories about muni fundamentals, which rarely make headlines, are much more common these days. 

Another positive sign for munis is that certain key sectors of the market continue to show good long-term potential and offer additional yield over comparably rated sectors.

For example, the healthcare sector is benefitting from the Patient Protection and Affordable Care Act, which forces cost controls on nonprofit healthcare organizations. In our view, to achieve these efficiencies, strong nonprofit healthcare entities will be forced to lower costs, or merge with other systems to achieve economies of scale.   A healthcare sector with better vital signs favors strong long-term bond performance in the years ahead. 

Good fundamentals are clearly there for the investor looking for long-term opportunities in munis – and the price is right, too.  Long-dated A-rated tax-exempt muni bonds are currently trading at higher yields than similarly structured A-rated corporate bonds, as reported by JP Morgan. This mispricing has only occurred three times in 13 years,  and each time it’s been followed by a rally as the yield mispricing pulls more capital into the market – which could further improve conditions for muni issuers.

We believe the muni market can be a dynamic opportunity, but what hasn’t changed is the difficulty of navigating the market. With more than 87,000 issuers and no central exchange, it is essential to work with an insightful and experienced manager, backed by expert research and a strong network of dealers. In our opinion, this can make all the difference in achieving good risk-adjusted returns and, more importantly, in prudently avoiding pitfalls, such as Puerto Rico.  Finding the right partner, a good rule of thumb for any investment, applies even more strongly to municipal bonds.

Robert DiMella is an Executive Managing Director and Co-Head of MacKay Municipal Managers, part of New York Life Investments. Robert is also co-Portfolio Manager of the MainStay Tax Free Municipal Bond Fund. He has been a municipal portfolio manager since 1993 and has a broad range of experience in the municipal market.