Untapped Opportunities in Unrated Municipal Bonds

The municipal bond market is large and highly fragmented with more than $4.3 trillion distributed across more than one million distinct bonds and 50,000 issuers.¹ This fragmentation has resulted in significant dispersion of yields and prices for similar bonds, a dynamic that has provided skilled credit managers with ample opportunity to leverage their underwriting acumen to identify potential mispricings in the market.² 

We believe that this opportunity is particularly abundant within the large cohort of unrated bonds. Often due to cost relative to issue size, municipalities sometimes forego bond ratings by nationally recognized statistical rating organizations (NRSRO) such as Moody’s or S&P Global. For these unrated bonds, a prospective investor is solely responsible for assessing the bond’s creditworthiness. To compensate for greater complexity and information risk involved with these bonds, however, they typically pay investors a higher yield compared to rated issuers of similar quality.

Unrated bonds are not necessarily risker than rated bonds. While unsecured corporate bonds are typically backed by the creditworthiness of the issuer, municipal bonds—including unrated issues— generally come with greater security and are backed by the full faith and credit of the issuing municipality or income streams from specific projects.

Independent credit work on nonrated munis may be especially rewarding because the significant dispersion of yields and pricing among unrated bonds suggests potentially rich opportunity for skilled analysts to uncover favorable yields and returns relative to credit quality and default risk.