High yield municipal bonds occupy a distinct niche within the broader municipal bonds market. They combine the tax advantages traditionally associated with municipal bonds and the higher income potential commonly linked to high yield sectors of fixed income. For investors in elevated tax brackets, high yield municipal bonds can provide compelling after-tax income, but the additional return comes with material risks.
This article examines the structure, benefits, and risks of high yield municipal bonds, compares them with investment grade municipal bonds, and reviews how mutual fund and ETF structures—such as the high yield muni segment—fit into diversified portfolios.
High yield municipal bonds are municipal bonds issued by states, cities, counties, and public authorities, but with credit ratings that are below investment grade or with no credit rating at all. In other words, they are non investment grade municipal bonds. However, unrated or lower-rated securities are not necessarily of low quality; rather, they are considered higher risk and may fall into a higher-risk category such as below investment grade.
The Bloomberg High Yield Municipal Bond Index tracks the performance of municipal bonds rated below investment grade and those that are unrated. This benchmark reflects the core of the high yield municipal market and highlights its distinct risk-return profile.
Unlike investment grade municipal bonds, which are typically backed by broad tax bases or established revenue systems, high yield municipal bonds often fund specific, riskier projects such as development, charter schools, or senior housing, rather than general obligations backed by tax revenues. These may also include nursing homes, hospitals, economic and industrial development initiatives, and medical facilities—entities that often have volatile revenue streams. As a result, the credit quality of high yield municipal bonds depends more heavily on project-level revenues and operational success. High-yield municipal bonds are often issued by entities with greater operational risk compared to investment-grade issuers. The high-yield municipal bond market is made up of issuers that generally have a greater degree of operational risk compared to investment-grade issuers.
High yield municipal bonds are generally issued by municipalities, and their interest payments are typically tax exempt at the federal level. In many cases, interest is also exempt from state and local taxes if the investor resides in the issuing state, though some income may still be subject to state income taxes or the federal alternative minimum tax.
One of the defining features of municipal bonds is their ability to generate tax exempt income. High yield municipal bonds generally offer interest payments that are exempt from federal income taxes. For investors in higher tax brackets, this can significantly increase the effective yield relative to taxable fixed income securities.
In 2026, the expected tax-equivalent yield for high yield munis is approximately 9%, compared to about 6% for investment grade municipal bonds. For investors subject to elevated federal income taxes and state income taxes, high yield municipal bonds can yield more than high yield corporate bonds on an after-tax basis.
This advantage becomes particularly meaningful for investors in higher tax brackets seeking to optimize risk adjusted returns. While investment grade municipal bonds provide stability, high yield municipal bonds typically offer higher yields due to their lower credit ratings and increased risk.
For high-income investors, especially those exposed to both federal income taxes and state or local taxes, high yield municipal bonds may represent an efficient asset class for tax-sensitive income generation.
Credit ratings play a central role in evaluating municipal bonds. Investment grade municipal bonds are generally considered to have lower credit risk compared to high yield municipal bonds. By contrast, high yield municipal bonds are often unrated or rated below investment grade, indicating a higher probability of default.
Credit risk refers to the possibility that an issuer will fail to make scheduled interest payments or repay principal payments at maturity. High yield municipal bonds are considered more vulnerable to missing interest payments or failing to repay principal compared to investment-grade bonds.
Approximately 85% of all municipal defaults occur in the high-yield or unrated sector. Although defaults in the municipal bond market are rare overall, they are more likely to occur in the high yield municipal segment.
However, historical data show that high yield municipal bonds often have lower default rates than corporate high yield bonds. Over a 10-year period, municipal high yield default rates have been about 3.97%, compared to roughly 32.53% for corporate high yield bonds. This distinction underscores that while high yield municipal bonds are non investment grade, they may still present a different risk profile than corporate counterparts.
Interest rates are a critical driver of bond prices across fixed income markets. When interest rates rise, bond prices generally fall. High yield municipal bonds are subject to interest rate risk, and their principal value can fluctuate as interest rates change.
Interestingly, high yield munis are often more sensitive to the economic health of the underlying project than to general interest rates. Still, periods when interest rates rise can create downward variations in net asset value for high yield muni mutual fund and ETF structures.
High yield municipal bonds also tend to have a higher correlation to equities than investment grade municipal bonds. This higher correlation may limit their diversification benefits during equity market stress. At the same time, high yield munis can provide better diversification due to their low correlation to certain other fixed income securities, depending on the broader market environment.
The high yield municipal bond market is smaller and less liquid than the Treasury or corporate bond markets. Liquidity risk can become pronounced during market stress, making it harder to sell positions without affecting bond prices.
High yield municipal bonds are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. Issuers may redeem bonds early if interest rates drop, which is known as call risk. This can affect expected income streams and total return.
High yield municipal bonds are often issued by entities with volatile revenue streams. Local political, economic, social, and environmental conditions may adversely affect performance. For example, the Invesco High Yield Municipal Fund may be adversely affected by local political and economic developments in the jurisdictions of its issuers.
In 2026, record supply pressures for high yield munis are projected to reach approximately $600 billion. If investor demand does not keep pace, total returns may lag expectations. Supply-demand imbalances can influence yield municipal spreads and affect both new issuance pricing and secondary market performance.
Careful research and analysis are essential when considering high yield municipal bonds as part of a fixed income portfolio. Unlike investment grade municipal bonds, which typically offer greater stability and lower credit risk, high yield municipal bonds require a more thorough evaluation of the issuer’s financial health, the underlying project’s viability, and the broader economic environment.
Investors should pay close attention to credit risk, as the likelihood of missed interest payments or principal loss is higher in the high yield municipal segment. Assessing the credit quality of the issuer, understanding the sources of revenue backing the bond, and reviewing recent credit ratings can help investors gauge the risk profile of a particular security.
Interest rates also play a significant role in the performance of high yield municipal bonds. When interest rates rise, bond prices generally decline, which can impact the value of both individual bonds and yield municipal mutual funds or exchange traded funds. Additionally, liquidity risk is a key consideration, as high yield municipal bonds may be more difficult to buy or sell quickly, especially during periods of market stress.
Given these complexities, investors are encouraged to review the fund’s prospectus thoroughly and seek guidance from a financial professional before making investment decisions. A disciplined approach to research and analysis can help investors balance the potential for higher yields with the risks inherent in this asset class, ensuring that high yield municipal bonds align with their broader investment strategies and risk tolerance.
Given the complexity of credit analysis in the high yield municipal sector, many investors use a professionally managed mutual fund or exchange traded funds structure. A professional manager can help with diversification, ongoing credit monitoring, and portfolio construction.
For example, the Invesco High Yield Municipal Fund invests in obligations exempt from regular federal individual income taxes issued by U.S. territories and commonwealths. The iShares High Yield Muni Active ETF has an identical investment objective and substantially similar investment strategies and risk profiles as its predecessor mutual fund.
As of February 18, 2026, the average yield to maturity for the iShares High Yield Muni Active ETF is 5.99%. Certain funds feature portfolio management by Nuveen Asset Management, LLC, an affiliate of Nuveen, LLC.
When evaluating a high yield muni mutual fund, investors should review share classes, including Class C structures, sales charges, management fees, and potential fee waivers. Fee differences across share classes can materially affect net asset and net asset value outcomes over time. Such waivers may temporarily reduce expenses, but they may not persist.
Investors should carefully review the fund's prospectus and current prospectus, including important disclosures regarding management fees, sales charges, and expense ratios.
Past performance is frequently highlighted in marketing materials, often alongside a morningstar rating. Ratings such as Morningstar's are based on comparing a single population of funds with similar characteristics to ensure meaningful benchmarking. However, past performance does not guarantee future results. Performance does not guarantee future performance, and neither morningstar nor other content providers can predict future results.
Data contained in fund materials are often for illustrative purposes and may reflect fee waivers or other adjustments. Investors should consider original cost, dividend amount, capital gains distributions, and changes in principal value when evaluating total return.
The relevant index for high yield municipal bonds, such as the Bloomberg High Yield Municipal Bond Index, may differ in composition from actively managed funds. Losses arising from market stress, credit deterioration, or liquidity risk are possible. Investing involves risk, including potential loss of principal value.
High yield municipal bonds are part of the broader fixed income asset class, but they differ meaningfully from investment grade securities. Investors should understand that investing involves risk and that past performance and current performance do not guarantee future results or future performance.
Investing in high yield municipal bonds may be appropriate for investors in higher tax brackets who are comfortable with the added risks. These bonds may offer rewarding consistent performance in stable economic periods, but consistent performance cannot be assumed.
Investors should align high yield municipal exposure with their overall investment strategies and tax situation. For some, more emphasis on investment grade municipal bonds may be appropriate, particularly for those seeking lower credit risk and greater stability.
Because the high yield municipal bond market is less liquid and more specialized, consulting a financial professional or broker dealer may help investors make informed investment decisions.
High yield municipal bonds combine tax exempt income with higher income potential than investment grade municipal bonds, but they also introduce materially higher credit risk, liquidity risk, and sensitivity to issuer-specific developments. For investors in higher tax brackets, the tax-equivalent yield can be attractive, particularly when compared with taxable high yield alternatives. However, investing involves risk, including potential principal loss, and performance does not guarantee future results.
The high yield municipal market requires careful analysis of credit ratings, underlying project fundamentals, interest rate exposure, and structural features such as call provisions. Given the complexity of this asset class and the wide dispersion in credit quality, investors should carefully review important disclosures, the fund's prospectus where applicable, and consider whether this segment fits their broader investment strategies and risk tolerance.
Bondfish can support this process by helping investors screen and compare municipal bonds within a broader fixed income universe. By structuring information around yield levels, maturity profiles, and issuer characteristics, investors can approach high yield municipal exposure in a more disciplined and transparent way when making investment decisions.
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