With fixed income investors looking for higher yields, Build America Bonds may fit perfectly in their plan. Enacted as part of the 2009 economic stimulus package signed into law by President Obama, Build America Bonds present an excellent opportunity for investors to generate substantial returns with lower risk vehicles.
How They Work
Build America Bonds are issued by municipalities, just like any other municipal bond, and they are subsidized by the Federal Government at 35% of the interest expense. Thus, $100 million in bonds issued at 7% would yield $7 million in interest, with the Federal government chipping in $2.45 million of the cost. Since such a large amount of the interest cost is defrayed by Federal coffers, investors have access to an asset class halfway between the risk of municipal debt and US Treasuries that generate returns similar to riskier corporate debt.
To compare, municipal debt obligations have a default rate of .06%, while AAA rated corporate debt has a 2.25% failure rate. The risk to reward certainly favors municipal debt.
Despite being subsidized by the US government, Build America Bonds earn the same tax treatment as municipalities. As such, investors who earn 7% through a Build America Bond issue would keep the full 7%, providing an excellent opportunity to earn municipal returns with generally lower risk, since the municipality pays only 65% of the interest expense.
Getting started in Build America Bonds has been made easier by InvescoPowerShares, which launched the PowerShares Build America Bond Portfolio (BAB) with an extremely low .28% annual fee. For such broad diversification, the .28% annual fee is of little consequence to investors who have diversification within the new asset class.
Municipalities Look Great
For those reaching retirement age, there have never been better opportunities in municipal debt. With spreads between corporate debt and municipal debt growing thin, and taxes on everyone’s mind, municipal bonds offer the chance for extraordinary income. Those with long timeframes before retirement should tread carefully, however, as higher interest rates in the future could mean paper losses on debt obligations until maturity.