Bonds That Build Roads

When you invest in a municipal bond, or "muni," you are among investors who are lending money to a state or locality for the financing of various government services, which often include building or maintaining roads, bridges, sewers and other infrastructure projects. For investors seeking a reliable source of income, such bonds may be a good option, as munis tend to be high in quality and, in the case of revenue bonds, are backed by user fees, such as highway or bridge tolls.

"Infrastructure has traditionally been one of the better cash flow investments," says Chris Hyzy, chief investment officer for Bank of America Global Wealth & Investment Management, noting that bond yields around the world are currently low and are likely to remain that way for the next decade. "This makes muni bonds an attractive choice for many investors in search of cash flow."

Munis can offer important tax advantages too. Martin Mauro, head of Fixed Income Strategy and co-head of Wealth Management Investment Strategy for BofA Merrill Lynch Global Research, notes that the interest from munis is generally exempt from federal taxes. "And in many cases, if you buy a bond from your home state, you won't pay state income tax on the interest either."

In addition, munis tend to have both low volatility and low correlation to other investments—that is, their value doesn't tend to rise or fall with that of other kinds of assets, such as stocks.

But munis can present risks. For example, a downturn in the economy can cause infrastructure projects to grind to a halt, says Hyzy. And rising fuel prices could deter travelers, leading to a drop in revenue at bond-supported airports and toll roads. That could in turn dry up cash flow needed to make interest payments. The ultimate risk, of course, is that bond issuers could default on their obligations to investors.

Such risks can be minimized by ensuring that a bond is backed by solid funding, says Hyzy. He also predicts that a new wave of tax-advantaged offerings akin to Build America Bonds (BABs) could be on the horizon. BABs were created by the U.S. Treasury Department in 2009 to help stimulate investment in local infrastructure projects during the most recent recession, but expired in 2010. If the current projected funding shortfall for U.S. infrastructure needs is any indication, a new crop of BABs could be a real possibility. With that could come even more opportunities for investors to help rebuild America.