Morningstar - Q2 2021 - 31

EXHIBIT 3

with lower credit ratings-had the lowest
correlation with equities during the period of any
of the muni groups in our sample. That was
surprising in that lower-rated taxable bonds were
notably weak diversifiers for equities during
the period.
Moreover, state and municipal finances have
come under pressure during the pandemic
as a result of pandemic-related outlays and
declining tax receipts. However, high-yield munis
may have benefited from their higher absolute
yields, which provide a cushion against losses, as
well as their relative illiquidity. The fact that
fewer of these bonds changed hands during this
period helped hold their prices aloft.
While New York City bore the brunt of the
pandemic early on, accounting for a large
percentage of pandemic-related hospitalizations
and deaths, municipal-bond funds focused
on New York state were no worse as diversifiers
than were broadly diversified municipalnational funds. The same was true for Californiafocused funds.

2020 Correlation Matrix Municipal Bonds
Time Period:
01/2020-12/2020

1.00 to 0.80
0.80 to 0.60

0.60 to 0.40
0.40 to 0.20

0.20 to 0.00
0.00 to -0.20

Morningstar US 1-5 Yr Treasury Bond
1
2
Morningstar US Core Bond
Morningstar US Cash T-Bill
1 Morningstar US Market TR
1.00
Index

2 Morningstar US Core Bond TR

-0.20 to -0.40
-0.40 to -0.60

0.25

1.00

-0.53

0.56

1.00

4 US Fund High-Yield Muni Category

0.45

0.36

-0.30

1.00

5 US Fund Muni National Interm Category

0.41

0.42

-0.18

0.96

1.00

6 US Fund Muni National Long Category

0.41

0.42

-0.17

0.97

1.00

7 US Fund Muni National Short Category

0.50

0.42

-0.25

0.93

0.98

3 Morningstar US Treasury & Govt. Bond TR

Source: Morningstar Direct. Data as of 12/31/2020.

01/2004

01/2007

01/2010

01/2013

Rolling 3-Yr
7
Correlation
0.4
0.06

01/2016

0.0
-0.36
1.00

-0.4
-0.50
0.97
1.00
-0.8

01/2019

EXHIBIT 4

Municipal Bonds as Diversifiers Correlations with equities have risen over
the past decade.
US Fund High-Yield Muni Category

Rolling 3-Yr
Correlation
1.0

US Fund Muni National Interm Category

E X H I B IT 3 shows the correlations between
various municipal-bond investments and the U.S.
equity market for 2020.

0.33 0.5
0.28

Longer-Term Trends
Over the past 20 years, municipal bonds have
had a slightly negative correlation with
equities. However, all muni categories had a
higher correlation with equities than did
the Morningstar US Treasury & Government Index
and the Morningstar US Core Bond Index.
In short, high-quality taxable-bond exposure
has been a better portfolio diversifier than
municipal-bond exposure.

01/2004

Munis' correlation with equities has also risen
a bit over the past decade. Whereas correlations
with equities were mostly negative in the
20-year period from 2001 to 2020, they nudged into
positive territory from 2011 to 2020 ( E X H I BI T 4 ).

Across all longer-term time frames, high-yield
municipal bond funds were the least
effective diversifiers for equities of any municipalbond-fund group. That's similar to the trend for
high-yield taxable bonds; they're much less
defensive and more sensitive to economic stress
than high-quality bonds.

Their correlation with equities have also jumped up
at an unappealing time-when equities have
slumped. They did so in the financial crisis from
2007 to 2009 and again in early 2020.

-0.60 to -0.80
-0.80 to -1.00

0.0

-0.5
01/2007

01/2010

01/2013

01/2016

01/2019

Source: Morningstar Direct. Data as of 12/31/2020.

Portfolio Implications
Municipal bonds have provided a decent, although
certainly not perfect, diversifier with equities.

Over longer periods, munis have exhibited a higher
correlation with equities than high-quality
taxable-bond indexes, especially Treasury bonds.
One of the key reasons may be that the muni
market is less liquid than that of Treasuries, and it
has often seized up in periods of equity market
stress. That suggests that even investors who put
a high value on the tax-saving features of
municipal bonds should consider augmenting
them with U.S. government bonds for
diversification benefit and ballast during equity

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