8 Best Municipal Bond Funds to Buy and Hold

Muni bond funds are attractive to investors in high tax brackets.

Investors who are looking boost their portfolio's income may want to consider tax-free municipal bond funds. Dunkin Allison, co-chief investment officer at Delegate Advisors, says muni bonds' recent performance is strong, driven by solid U.S. economic growth and low unemployment, plus low supply and a strong demand because of the historically low interest rate environment. When Allison analyzes muni bond funds, he looks at credit quality versus the risk taken, duration and cost. In the current interest rate environment, he prefers short-duration bond funds, those with five years or less to maturity. Here are eight muni bond funds for buy-and-hold investors to consider.

Nuveen Select Tax-Free Income Portfolio (ticker: NXP)

Chuck Self, chief investment officer for iSectors, says he uses NXP, which is a closed-end fund. Self says 80% of NXP's holdings are investment grade, and it is one of the few closed-end funds with less than 1% leverage, reducing risk. The fund has a tax-free income return of 3.75% and currently trades at a 4% discount to its net asset value, which Self says is normal for the fund. "The low leverage means it takes on less risk, which makes it a superior choice," he adds. The expense ratio is 0.26%, which amounts to $26 for every $10,000 invested.

Vanguard Tax-Exempt Bond ETF (VTEB)

Marc Pfeffer, chief investment strategist at CLS Investments, says he likes VTEB for its high-credit offerings and very low cost, calling Vanguard a "premier player in the muni bond space." VTEB's expense ratio is 0.08%, one of the lowest among its peers. The exchange-traded fund tracks a market-weighted index of investment-grade debt from state and local governments and governmental agencies. The fund is tax free at the federal income tax level and free from the alternative minimum tax. The yield is 3%.

VanEck Vectors AMT-Free Short Municipal ETF (SMB)

For more conservative investors, Pfeffer suggests SMB. He says it's appropriate for people who want less risk because it holds shorter maturity bonds. The ETF tracks a market-weighted index of tax-exempt municipal bonds with maturities of one to six years, with a weighted average of 4.45 years. The fund holds a mix of revenue bonds, which comprise 58% of the holdings, with general obligation bonds making up 37%. Bonds from New York, California and Texas are among the top three holdings. Because the duration is shorter, the yield is a bit smaller at 1.75%.

PIMCO Enhanced Short Maturity Active ETF (MINT)

Allison says in the muni bond space, his firm leans to actively managed bond ETFs. He says there are opportunities for portfolio managers to perform better than their benchmark. In a low-return environment, costs are important when looking at actively managed funds, which usually have higher fees than passive ETFs. "If you're paying that's 1% or more, you're eating into a tremendous amount of return," he says. An example of a low-cost, short-duration actively managed bond fund is MINT, which invests in high-quality, domestic and foreign debt with duration under one year. It has a 0.42% net expense ratio, and it's considered reasonable compared with its peers.

SPDR Nuveen Bloomberg Barclays Short-Term Municipal Bond ETF (SHM)

Steve Wagner, CEO of Omnia Family Wealth, says his firm prefers to hold fixed income with short duration, meaning holdings mature in five years or less. "With the yield curve as flat as it is, you don't get paid really to take the risk on the long term," he says. When choosing a bond fund, Wagner looks for inexpensive fees, so costs don't eat into the return. An example of a short-term muni bond ETF is SHM, which has a higher credit rating than the category norm, since nearly all of its assets are in securities rated AA or higher. The majority of its holdings mature in five years or less.

VanEck Vectors High-Yield Municipal Index ETF (HYD)

For investors who are willing to take on a little bit of extra risk for bigger return, should look at HYD, Pfeffer says. The fund tracks a market-weighted index of high-yield, long-term and tax-exempt muni bonds, and it's one of the few high-yield muni bond ETFs. Assets under management are large at $2.7 billion, which Pfeffer says is a sign of strong liquidity. Year to date it has a yield of 4.03%. Ninety percent of the fund's holdings are revenue bonds, with 13.5% from California and 13% from Illinois, the top two states. "I think this is an attractive fund," he says.

Pioneer Muni High Income (MAV)

Jason Escamilla, CEO of ImpactAdvisor, says he uses MAV for clients who are looking for a higher yield. MAV is a closed-end fund with holdings exempt from regular federal income tax for most investors. It's currently trading at an 8% discount to its net asset value and has a yield of 4.75%. Escamilla says the current 8% discount is greater than the fund's 12-month average discount. This provides a margin of safety or potential for better resale value at some point in the future, he says.

Invesco New York AMT-Free Municipal Bond ETF (PZT)

With the changes in the tax code, residents living in high-tax states like California and New York can benefit from buying tax-free municipal bonds, Pfeffer says. For New York residents, he likes PZT, which has been returning significantly more yield than its peer iShares New York Muni Bond Fund (NYF). Part of that bump in yield is due to that it holds long-dated bonds with at least 15 years to maturity. Its holdings are not only in New York but also Puerto Rico. He notes the longer maturity increases the interest rate risk. It has a year-to-date yield of 4.12%.

Consider these muni bond funds for your portfolio.

-- Nuveen Select Tax-Free Income Portfolio (NXP)

-- Vanguard Tax-Exempt Bond ETF (VTEB)

-- VanEck Vectors AMT-Free Short Municipal ETF (SMB)

-- PIMCO Enhanced Short Maturity Active ETF (MINT)

-- SPDR Nuveen Bloomberg Barclays Short-Term Municipal Bond ETF (SHM)

-- VanEck Vectors High-Yield Municipal ETF (HYD)

-- Pioneer Muni High Income (MAV)

-- Invesco New York AMT-Free Municipal Bond ETF (PZT)

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