• In pursuit of tax-exempt income, municipal bond SMAs provide high-net-worth investors with investment solutions backed by institutional-quality credit research, risk analytics and trading scale.
• The SMA structure combines the potential benefits of institutional management with the direct ownership of individual munis, providing clients and their advisors with transparency, liquidity and enhanced control.  
• Guided by insights from financial advisors, SMA managers can help optimize a client’s potential after-tax income and preserve wealth over the long term. Beyond tax considerations, however, limiting a manager’s investment discretion may diminish the impact of professional expertise and negatively affect portfolio returns.
• Partnering with an external SMA manager can help advisors focus on comprehensive client services beyond portfolio construction and ultimately may add value to their practices.

Individual investors have long been the primary source of demand for municipal bonds given the tax advantages on offer; households hold about 70% of outstanding securities both directly and through mutual funds and exchange-traded funds (ETFs).¹ For investors with substantial assets, direct ownership has long been preferred over commingled funds, and direct ownership increasingly has taken the form of separately managed accounts (SMAs). While muni SMAs had just $100 billion in assets under management in 2008, this figure surged to an estimated $1.2 trillion in 2025—more than a quarter of the muni bond market as a whole.²

The job of the financial advisor has grown more complex in recent years as the industry has adopted a more holistic approach to client relationships that emphasizes a range of comprehensive, high-touch services beyond portfolio construction. Concurrently, advisors have increasingly recognized that partnering with an external SMA manager can facilitate this shift while also adding value to their practices.

Providing investment solutions backed by institutional-quality credit research, risk analytics and trading scale, municipal bond SMAs, in our view, are a particularly compelling option for advisors seeking attractive after-tax outcomes for their clients.

Investment Solutions Aligned with Client Needs

The $4.4 trillion municipal bond market—with 50,000 issuers and more than one million bonds outstanding—is large, highly fragmented and inefficient.³ The resulting dispersion of yields and prices for similar bonds, in our view, represents an opportunity for active investment managers to apply their underwriting skills—amplified by institutional access to bonds, better pricing and lower trading costs—to build muni bond portfolios that may be more likely to deliver better returns than through other methods.

Tax efficiency. While income that is free from federal taxes has long been the calling card of municipal bond investment, not all muni bonds have this feature. In 2025, for example, 90% of municipal issuance was tax exempt; the remaining 10% was taxable for all investors or incurred taxes only for high earners exposed to the alternative minimum tax (AMT).⁴

Private-activity bonds—revenue bonds in which more than 10% of the proceeds are applied to private business use—such as the construction of affordable housing or dorms for a private college, are generally taxable for AMT-paying investors. General-obligation and public-purpose revenue bonds, meanwhile, typically shield investors against all taxes at the federal level. There is nothing inherently wrong with investing in taxable munis—more often than not they will offer higher nominal yields as compensation—but their impact on after-tax yields can vary significantly based on an individual’s circumstances and must be carefully considered when constructing a portfolio.

Individuals, especially those in high-tax states, may further benefit from the preferential tax treatment of bonds from issuers in their state of residence. Leveraging this advantage is not without its challenges, however. With muni bond issuance dominated by California, New York and Texas, investors in other states may find the investment pool lacking in depth, while those living in states with low or no state income taxes, like Texas and Florida, derive no additional tax benefits from staying home. Triple-tax-free income—federal, state and local—may be accessible to residents through bonds issued by cities, counties and local agencies, but these generally have even less diversification potential.

Importantly, the tax management activities of an SMA manager are not limited to a client’s muni bond exposure. Unlike commingled structures such as mutual funds/ETFs, the underlying securities in an SMA are owned directly by the investor, who in turn only pays taxes on capital gains generated by their own holdings. Moreover, SMA managers—guided by the holistic view into a client’s overall portfolio provided by the financial advisor—can implement tax-loss harvesting plans to reduce an investor’s tax liability broadly, such as selling bonds for a loss that can be used to offset capital gains from investments in other asset classes. Meanwhile, the tax-lot selection available to SMA clients can help optimize both the harvesting of losses and the realization of gains and help improve long-term after-tax returns.

Credit risk management. Municipal bonds—whether general obligation bonds backed by the full faith and credit of the issuing municipality or revenue bonds funded from specific cash flows—historically have had very few incidents of default relative to corporate issues. The default rate for muni bonds over a five-year horizon was just 0.08% compared to 7.06% for global corporates, and even high yield munis alone, at 4.55%, had a superior default rate relative to corporate offerings.⁵

While securing differentiated yield at the upper end of the muni bond quality spectrum can be a challenge, we believe bonds rated AA and A generally offer skilled underwriters an attractive blend of income and resilience. Return potential may be further enhanced by diversifying credit risk across both investment grade and high yield munis. Diversified exposure to individual high yield munis can be a challenge in most SMA accounts, given their size, but the inclusion of a high yield completion fund can make such exposure feasible.

Interest rate risk management. Like all fixed-coupon securities, municipal bonds carry interest rate risk. Duration is a common measurement of the sensitivity of a bond’s price to changes in interest rates that managers closely oversee against an evolving interest rate environment. Importantly, they will manage portfolio positioning across the yield curve, as interest rate changes can affect varying bond maturities differently. Beyond risk management, effective yield curve positioning can also enhance income potential.

For municipal bond portfolios, convexity is another key concern, particularly as rates have normalized in recent years. While duration assumes a linear relationship between bond prices and interest rate changes, convexity captures the curvature of the relationship (i.e., how a bond’s duration changes as interest rates change). While a number of factors can influence a bond’s convexity, including price, coupon, yield and time to maturity, callability is among the most impactful, and nearly 90% of municipal bonds issued in 2025 had call provisions, typically at par after 10 years.⁶

In contrast with the positive convexity of non-callable bonds, callable bonds tend to exhibit negative convexity. As a result, interest rate changes have an asymmetrical price impact on callable bonds, with greater exposure to the downside. This is to say that a bond’s duration contracts when rates fall, muting price increases, and extends when rates rise, amplifying price declines.

Some SMAs allow clients to sidestep specific types of municipal bonds in their accounts. However, we would warn that limiting a manager’s discretion may diminish the impact of professional expertise and negatively impact portfolio returns.