Why Are Municipal Bond Funds Experiencing Losses in 2025?
Key Takeaways
- Municipal bond funds are underperforming while taxable bond categories are seeing gains.
- Increased issuance and market volatility have led to declining municipal bond prices.
- Valuations for muni bonds now appear to be quite attractive for buyers.
It’s been a tumultuous time for municipal bond funds in 2025! While many bond categories thrive with positive returns, one area stands out for its dismal performance: municipal bonds. Despite the challenges, Paul Malloy, head of US municipals at Vanguard—which manages a whopping $260 billion in tax-exempt assets—believes this downturn may present a golden opportunity for savvy investors. “Munis are as cheap as it gets,” he insists.
The Numbers Tell the Story
The average national municipal bond fund is down 0.6% year-to-date. Even longer-term muni bond funds and high-yield munis (which invest in lower-quality tax-exempt debt) are down 1.5%. This stark contrast is highlighted by the 3% return seen on average intermediate core bond funds. Out of 17 tracked categories of tax-exempt funds, only two are celebrating positive performance. Meanwhile, not a single one of the 15 taxable bond fund categories has endured losses this year.
Tragically, of the 481 U.S. municipal bond funds with over $100 million in assets, nearly 80% are in the red. The Vanguard Intermediate-Term Tax-Exempt Fund (VWIUX), the largest of its kind with $78 billion, has lost 0.4% in 2025. In stark contrast, the poorly performing Redwood Managed Municipal Income Fund (RWMIX) has plummeted by 4.9%.
Why Are Muni Bond Funds Suffering?
Malloy attributes the losses to a combination of factors. First and foremost, he explains, valuations were already high at the start of the year. “Munis started the year relatively rich,” he states. This inflated valuation was largely influenced by the rise of separately managed muni accounts for shorter-term bonds, leading to a rush of investment that disregarded valuation.
Secondly, the supply of new bonds surged after years of lagging issuance. Malloy notes that many issuers were quick to enter the market to hedge against the anticipated uncertainties stemming from the new administration’s economic policies.
Volatility: The Municipal Market’s Foe
The increasing supply of muni bonds coincided with significant market volatility, prompting many investors to withdraw their funds. “We noticed volatility in the broader fixed-income markets, especially in longer-term maturities,” says Malloy. This unpredictability caused outflows from municipal ETFs and added pressure to the already struggling high-grade segment of the market.
In March 2025 alone, investors pulled a staggering $381 million from municipal bond funds—with a remarkable $6 billion flowing in just a month prior. Malloy highlights a trend: municipal investors, known for seeking stability and income, can quickly become skittish amid tumultuous conditions.
The Tax-Exempt Status Remains Untouched
Recent whispers about potentially changing the tax-exempt status of municipal bonds ignited concern, following remarks from Stephen Moore—a casual economic advisor to former President Trump. However, Malloy reassures us that these speculations carry a low probability, given the critical role the municipal market plays in infrastructure across all states. Therefore, it’s unlikely these discussions contributed to the market’s recent tensions.
Looking Ahead: Munis as a Golden Opportunity
Malloy sees the current volatility not as a danger but as an opportunity. He emphasizes that it shouldn’t affect the likelihood of defaults, especially for investment-grade municipal bonds. Local governments today are in excellent fiscal condition, bolstered by responsible fiscal policies and well-maintained rainy day funds.
While federal deficit concerns may contribute to rising Treasury yields, Malloy believes municipal bonds are fundamentally more secure due to their disassociation from federal governance. He reinforces the idea that “the safer place for long-end exposure is the municipal market.”
Moreover, as we emerge from 2024’s high valuations, tax-exempt bonds now present broader appeal. Surprisingly, the muni bond market is now cheaper than at any time in 95-99% of the past 15 years. “It basically makes sense for everyone, regardless of tax bracket, to consider owning municipals at this point,” insists Malloy.
Conclusion
In summary, while muni bond funds are currently facing headwinds in 2025, the landscape reveals potential for a turnaround. As valuations become more attractive, those willing to weather the storm may be positioned to reap substantial rewards. Understanding these dynamics can empower investors to navigate an ever-evolving market.
For further information and insights, check out resources like Morningstar for in-depth fund analysis and updates.
