High Yield Municipal Bonds: Tax-Advantaged Income

Key takeaways

1. For investors in certain tax brackets, high yield municipal bonds may generate higher tax-equivalent yields than other high-income sectors, including high yield corporate bonds.
2. High yield muni bonds have historically had less credit risk than corporate high yield bonds, proven by lower default and higher recovery rates.
3. The fragmented nature of the municipal bond market may create opportunities for active managers to identify attractive relative value opportunities.
4. The iShares High Yield Muni Active ETF (HIMU) seeks to deliver access to the high yield municipal market through an actively managed ETF strategy.

High yield municipal bonds occupy a unique segment of the fixed income market, offering the potential for tax-exempt income, attractive tax-equivalent yields and historically lower default rates than comparable high yield corporate bonds. For advisors evaluating income strategies for taxable investors, high yield municipals may represent a differentiated approach to generating tax-advantaged income.

Despite these characteristics, the high yield municipal market remains relatively underfollowed. The sector consists largely of smaller issuers, specialized projects and securities that often require extensive credit research to evaluate. While this complexity can make the market difficult to navigate, it may also create opportunities for experienced managers to identify attractive relative value opportunities. Today, investors can access a thoughtfully constructed high yield municipal portfolio through the iShares High Yield Muni Active ETF (HIMU), which combines active credit research with the accessibility and efficiency of the ETF wrapper.

What Are High Yield Municipal Bonds?

High yield municipal bonds are generally tax-exempt bonds that primarily finance project-based developments such as retirement communities, charter schools, healthcare facilities and land development projects. Unlike general obligation (GO) municipal bonds, most high yield muni bonds are not backed by a municipality's taxing authority. Instead, repayment is often tied to a specific revenue stream associated with the project, resulting in additional credit risk relative to investment-grade issuers.

While high yield municipals share some characteristics with high yield corporate bonds, there are several important distinctions — including tax-equivalent income potential, duration profiles, historical default experience and the prevalence of unrated securities—that may create compelling opportunities for investors.

High Yield Municipals vs. High Yield Corporate Bonds: Tax-Equivalent Yield Matters

When comparing municipal bond income with taxable bond income, stated yield only tells part of the story. Advisors often use tax-equivalent yield (TEY) to compare tax-free municipal income with taxable bond income on a more comparable basis. Tax-equivalent yield helps illustrate the value of tax-exempt income by converting a municipal bond's yield into its taxable equivalent.

For investors in higher tax brackets, tax-equivalent yields may exceed those available from taxable high yield bonds, making high yield municipals an attractive component of tax-aware investing strategies.

In addition to lower default rates and higher recovery rates, high yield muni products, like HIMU, may offer investors in the highest tax bracket a yield advantage over other high yielding bond products. Shown below, for clients in the 40.8% tax bracket, HIMU has offered an additional 140 bps in after-tax return over HY corporates.

Tax-Equivalent Yield Comparison: HIMU and High Yield Corporates

Performance data represents past performance and does not guarantee future results. Investment return and principal value will fluctuate with market conditions and may be lower or higher when you sell your shares. Current performance may differ from the performance shown. For most recent month-end performance see www.iShares.com. For standardized performance, click here.

Index performance is for illustrative purposes only. Index performance does not reflect any management fees or expenses. Indexes are unmanaged and one cannot invest directly in an index.

High Yield Municipals: A Longer-Duration Investment

High yield corporates have typically had shorter maturities because they have often funded companies with more near-term business and refinancing risks. High yield munis, on the other hand, have typically been issued to fund longer-term projects and, as a result, have historically had longer maturities – more in line with investment grade corporates. The effective duration of the Bloomberg High Yield Corporate Bond Index is 2.9 years, while the Bloomberg High Yield Municipal Bond Index is 7.2 years.¹ Because high yield municipals often fund long-term projects, investors are exposed to both credit risk and interest rate risk – meaning they need to understand how changes in both credit spreads and yield curves impact performance. For advisors, understanding this duration profile is important when evaluating how high yield municipals can fit alongside other fixed income allocations and broader portfolio objectives.

High Yield Municipals Have Historically Had Lower Credit Risk Than High Yield Corporates

An underlying characteristic of most high yield muni bonds may contribute to a lower default rate: security covenants. These covenants provide additional protection to high yield muni investors that high yield corporates may not offer. Common covenants include:

1. Limited tax-revenue pledge: Commitment by the issuer to use specific revenue streams to repay the bond holder.
2. Incremental tax pledge: Commitment by the issuer to use new tax revenues from a project to make debt payments.
3. First mortgage lien: A provision that gives bondholders priority on the property’s assets if the issuer defaults.

These additional protections may contribute to the lower average default rates, as was the case from 2021 to 2025: 0.50% for high yield munis, versus 1.48% for high yield corporates². The difference is even more pronounced when looking at the iShares High Yield Muni Active ETF (HIMU), which had a default rate of just 0.19% from 2021 to 2025.³

Average Default Rates, HY Corporates vs HY Municipals
2021-2025

Why Active Management Can Matter in High Yield Municipals

While the high yield municipal market can offer attractive income opportunities, accessing those opportunities may require active management due to its fragmented structure and the sheer volume of small issuances. For advisors building a municipal bond portfolio, active management may be particularly valuable given the market's size, fragmentation and prevalence of unrated securities.

To put it in perspective: there are approximately 6,000 high yield muni issuers versus about 2,000 high yield corporate issuers.⁴ And despite having three times as many issuers, the high yield muni market is roughly an eighth of the size of the high yield corporate market: $170B versus $1.5T⁵.

High Yield Municipals: More Issuers, Smaller Market

Additionally, unlike the high yield corporate market, where bonds typically have a rating of BB, B, or CCC, most high yield munis do not seek a credit rating, requiring a manager to perform their own research to determine if its yield is warranted given its risks. In fact, 70% of the bonds in the high yield muni index are unrated, versus virtually none in the high yield corporate index.⁶

There are several specific reasons why high yield munis may not be rated by an agency:

1. Too expensive: Small issuers may forgo a rating because it is too expensive or because the expected benefits don’t justify the expense.
2. Limited public information: Some high yield issuers don’t have enough public information available to allow them to be rated.
3. Private placements / limited offerings: Certain high yield muni bonds will be sold directly to a small group of institutional investors, bypassing the credit rating process of an agency.

Unrated bonds require additional credit research to assess relative value, creating opportunities for experienced managers to uncover mispriced securities.

Combined with the diversity of issuers — from retirement communities and hospitals to charter schools and land development projects — the high yield municipal market is particularly suited to managers with deep credit research capabilities and experienced portfolio managers.

The iShares High Yield Muni Active ETF (HIMU) is designed to help investors access opportunities across the high yield municipal market through BlackRock's dedicated municipal credit research platform and active portfolio management process. Investors seeking broader exposure to bond ETFs can explore how ETFs may be used across fixed income allocations and income-oriented investment strategies.

Armed with Aladdin risk management technology and sophisticated credit research tools, HIMU’s team of credit research analysts can identify attractive relative value opportunities amidst the thousands of small-issue high yield bonds – delivering them to clients through the accessible and efficient ETF wrapper.

Portfolio Construction and Implementation

Advisor Consideration

Before recommending a high yield municipal bond allocation, advisors should evaluate:

• Client tax bracket
• Taxable versus retirement account assets
• Income objectives
• Liquidity needs
• Existing municipal bond exposure
• Overall fixed income allocation

For many taxable investors, the most relevant comparison may be after-tax income rather than stated yield alone.

The role of high yield municipals within a portfolio depends on an investor's tax profile, income objectives and overall fixed income allocation. Advisors evaluating portfolio construction decisions can use Advisor Center 360 to assess how municipal bond exposures can fit within broader client portfolios.

For clients already holding investment-grade municipal bonds or taxable high-yield fixed income exposure, it may be worth evaluating whether a high yield municipal allocation could provide comparable or better tax-equivalent income with historically lower default rates.

Advisors seeking additional municipal bond exposure can explore BlackRock's broader municipal bond platform, which offers a range of solutions designed to support different income, duration and portfolio construction objectives.

For investors seeking actively managed exposure to the high yield municipal market, the iShares High Yield Muni Active ETF (HIMU) provides access to BlackRock's municipal credit research platform through the efficiency of the ETF wrapper.

Learn more about the iShares High Yield Muni Active ETF (HIMU) ->

HIMU product page

Explore more ways to access the high yield municipal market

For investors seeking to manage duration while maintaining high yield exposure, explore the iShares Short Duration High Yield Muni Active ETF (SHYM) ->

SHYM Product Page