The muni bond market grew within the second quarter as ownership by household and exchange-traded funds grew, while U.S. banks and insurers continued to cut back their holdings, the newest Federal Reserve data shows.

The face amount of munis outstanding ticked as much as $4.129 trillion, a 1.1% increase from the primary quarter of this 12 months and a 1.8% increase from the second quarter of 2023, in response to the newest Fed data.

The market value of munis was at $4.034 trillion, up 0.8% from the primary quarter and up 2% from Q2 2023.

Household ownership of individual bonds was the most important category of muni ownership at 44.6%, mutual funds at 19.2%, ETFs at 3.1% and U.S. banks at 12.4%. Life insurance firms own 4.6% and property and casualty insurers at 5.2%.

The muni market has at all times been retail-driven, but now “we’re really a retail-driven market,” said Matt Fabian, a partner at Municipal Market Analytics.

“Demand is coming from individuals … either directly through an SMA or through a mutual fund, and has been greater than sufficient to take down the big calendars that market has had,” he said.

Nonetheless, it isn’t as “reliable” in the long run, as a more diverse demand component could be higher, which makes the market a bit more resilient to what’s to return, Fabian said.

Once the Fed starts cutting rates, it’ll likely result in a unique yield curve, potentially changing individuals’ demand for munis, particularly if yields fall low enough to discourage them, he said.

“So if the form of the yield curve changes, it’s a matter about how individual demand may change,” he said.

Household ownership of munis — which incorporates direct ownership of individual bonds in brokerage accounts, fee-based advisory accounts and individually managed accounts — rose to $1.798 trillion, up 2.4% from Q1 2024 and 6.9% in Q2 2023.

The surge of SMAs greatly contributed to the expansion of household ownership, market participants said.

Although the Fed doesn’t carve out SMA ownership, Bloomberg Intelligence and others on the Street peg it at as much as $1.6 trillion of munis.

“The market has structural demand for income and equality, so it’s no surprise that SMAs are rising,” said James Pruskowski, chief investment officer at 16Rock Asset Management

The asset management world is creating simpler solutions and higher workstreams, in addition to technological advances, to permit SMA retail clients to enter the market, he noted.

SMA growth also stems partly from overall demand for tax-exempt paper, Howard said, noting this goes back to the 2017 Tax Cuts and Jobs Act, which included capping the state and native tax deductions, or SALT, said Cooper Howard, a hard and fast income strategist at Charles Schwab.

“For investors in states like California or Latest York, that caused a giant deduction and resulted of their tax rates moving higher, causing them to hunt down tax-exempt options,” he said, as munis are certainly one of the few available.

That has contributed to SMA growth given the importance of California and Latest York within the muni market, which has trickled into other parts, Howard said.

Moreover, household net value has increased to record level highs, pushing a lot of individuals who may not have been municipal bond buyers to now develop into muni buyers, he said.

Like SMAs, ETFs have mostly seen increases in ownership.

ETFs rose 1.7% from the primary quarter of this 12 months and 15.7% year-over-year to $124.4 billion.

“A cloth change has occurred within the muni ETF space, as the worth held at the top of June totaled $124 billion, up a formidable 93% since 2020,” said Kim Olsan, senior fixed income portfolio manager at NewSquare Capital. “The ETF balance in 2020 represented a 7% share of muni mutual funds, but has since grown to [nearly] 16% share.”

The ETF market has attracted a number of retail investors as they’re very acquainted with how ETFs trade, Howard said.

“It is a simplistic method to get exposure to the muni market,” he noted.

Anecdotally, money has been moving out of mutual funds into SMAs and ETFs, contributing to ETF growth outpacing mutual fund growth.

Fed data shows mutual funds barely increased their muni holdings quarter-over-quarter and year-over-year. Mutual funds owned $775.1 billion in Q2 2024, rising 0.5% from Q1 2024 and 1.5% from Q2 2023.

A part of the slight increase by mutual funds is “them not selling anymore, some inflows, and possibly a bigger part is market value gains,” Fabian said.

Nonetheless, mutual funds are still down 13% for the reason that end of 2020, Olsan noted.

Mutual funds are “still a crucial aspect of the market, but they’re beginning to lose a number of the importance due to the increase in SMAs and ETFs,” Howard said.

The foremost consider the expansion of ETFs is fees, said Roberto Roffo, a 30-plus 12 months muni veteran.

“As investors have develop into more conscious of fees, they’ve been drawn to the lower fee structure of ETFs, which on average are 50% lower than mutual funds,” he noted.
 
Moreover, ETF growth has been more significant than mutual funds because the “liquidity of ETFs and with the ability to trade all of them day long versus waiting until a mutual fund strikes its NAV at the top of the day is a giant draw,” Roffo said.

The fee structure is very important with regards to total return over an extended time period, he said.

“Most mutual funds manage to an index just like ETFs and typically outperform or underperform by a slim margin,” Roffo said.

“The extra fee structure of mutual funds robs from the performance over the long run and makes it far more difficult to outperform a given index which has zero fees, he said.

The lower fees related to ETFs make it “easier to compete versus its index over time since the fees aren’t subtracting as much from the performance,” in response to Roffo.

Meanwhile, banks proceed to shed their muni holdings.

Banks held were at $498.5 billion, down 3.3% quarter-over-quarter and 9.1% from Q2 2023. That is the bottom value since mid-2020, Olsan said.

“As banks were energetic buyers of long, low coupons within the 2020/2021 period, creation of long 2% coupons ceased in 2022 with rate hikes and subsequent trading ground to a halt on large losses,” she said. “Current yields have rallied in recent months to where vintage 2% production has shown material price recovery, potentially opening up the spigot for extra roll off of comparable structures in a declining rate environment.”

“The reduction in ownership by banks is a few selling, but additionally mostly banks aren’t reinvesting and steering their money into other asset classes,” Fabian said.

Up to now, changes in bank behavior have reflected actions at just just a few of the largest banks, which might have an outsized impact on those numbers, he noted.

Nonetheless, the pullback in Q2 was felt by nearly the entire top 20 banks cutting their muni holdings, in response to Fabian.

Bank holdings of munis, though, could have stabilized within the third quarter, he said, citing fata from the Federal Reserve Bank of St. Louis.

“Munis do not get any richer or any cheaper, so it might be that [banks] have not had their positions run off as quickly, or possibly banks are concerned that the company tax rate goes to rise, so it is smart for them to not lose all their muni holdings,” Fabian said.

Munis need banks, and banks like munis since the asset class is protected, long and connected to “constructing things,” that are all things that banks like about an instrument, he said.

“So, banks don’t necessarily need to do away with their munis, but sometimes they do,” Fabian said.