As the Tax Cut and Jobs Act (TCJA) enacted by President Trump in 2017 approaches its scheduled sunset in 2025, financial advisors are grappling with a critical portfolio decision: whether to increase their clients' municipal bond allocations, and by how much. With the potential for higher taxes looming, the tax-exempt nature of municipal bonds is becoming an increasingly attractive proposition for investors. However, the complex interplay of economic, political, and regulatory factors complicates the decision-making process, leaving advisors to carefully weigh their options and devise strategies that align with their clients' goals and risk tolerance.

Advisors Anticipate a Surge in Municipal Bond Demand as TCJA Sunset Nears

Preparing for the Tax Landscape Shift

Many advisors are closely monitoring the evolving tax environment and are poised to increase their clients' municipal bond allocations in anticipation of the TCJA's sunset. James Warner, a financial advisor at LPL and the lead wealth manager at the Warner Group, is considering raising some clients' municipal bond allocations by as much as 10 percent. "We will be keeping an eye on all the variations on this changing topic and will have to be ready to pivot quickly as the markets react," he said, emphasizing the importance of aligning strategies with each client's overall goals and risk tolerance.Eric Golden, the founder and CEO of the fixed income-focused fintech firm Canopy Capital Group, echoes this sentiment. He anticipates that advisors on his platform will likely increase their allocations to municipal bonds as the TCJA's 2025 deadline approaches, driven by the potential for higher taxes and the resulting spotlight on the tax-exempt nature of municipal bonds. "Advisors are expected to accelerate their extension into short-term and intermediate-term bond portfolios as the Fed continues to cut rates, allocating a greater percentage of their fixed income exposure towards municipal bonds," Golden said.

Early Movers and Cautious Observers

While some advisors are already taking action, others are taking a more cautious approach, waiting to see how the political landscape and economic conditions unfold. Janet Fox, a financial advisor at LPL and the president of ACH Investment Group, has already started increasing municipal bond positions in some client accounts and plans to further expand allocations to munis next year. "Some clients might be nervous about market conditions or the economy. Bonds might help mitigate some of that risk while paying the client interest," she said, noting that clients have various options for their municipal bond purchases, including individual issues, mutual funds, or ETFs.In contrast, Jeff MacDonald, the head of fixed income strategies at Fiduciary Trust International, is closely watching the election and potential policy changes, but is not adjusting his clients' portfolios in advance of any potential outcome. "The current Federal deficit is receiving a great deal of attention in this election season and both candidates' policy platforms involve multi-trillion-dollar deficits moving forward. Should the bond vigilantes decide to push back against this increased borrowing, it could usher in a period of higher yields and the lower bond prices that would accompany that adjustment," he cautioned.

Navigating the Uncertainty: Factors Influencing Advisor Decisions

Stash Graham, the managing director and chief investment officer of Graham Capital Wealth Management, foresees increasing his allocation to tax-free municipal bonds, but is waiting on a host of factors before making a move, including the result of the Presidential Election, the yield curve's shape, credit quality, and the direction of interest rates. "We prefer to maintain our fixed income exposure on the short end of the curve. We do this to limit our interest rate or duration risk. We still believe present and future risks with the long end of the yield curve could rise," he said, adding that he tends to focus more on general obligation bonds than revenue bonds backed by hospitals.Matthew D. Liebman, the founding partner and CEO of Amplius Wealth Advisors, is not increasing his municipal bond allocation, citing a lack of significant value in longer-term bonds currently. "The front end of the municipal curve can become a bit crowded, so we are maintaining balance by also holding some short-duration taxable bonds," he said. Furthermore, Liebman remains unconvinced that the TCJA will indeed sunset, believing a post-election deal is still possible, and is therefore standing pat on his municipal bond exposure at this time.Similarly, Don Bennyhoff, the founder of the fractional CIO for RIAs Bennyhoff & Co., believes "the factors affecting future muni performance are too unpredictable and multifaceted" to get ahead of the Presidential election or Congressional decision on tax cuts. He is taking a cautious approach, waiting to see how the political and economic landscape unfolds before making any significant adjustments to his clients' municipal bond allocations.