Key Takeaways
- Most municipal bond funds are posting losses, even as taxable bond categories are posting gains.
- Higher issuance and volatility have pushed down municipal bond prices, which started the year high.
- Valuations on muni bonds now look attractive.
In a year when most bond fund categories are in positive territory, there’s been one noticeable laggard posting losses nearly across the board: municipal bond funds. Driving this poor performance is a combination of stepped-up bond issuance, lofty starting valuations, and fund outflows amid the market’s recent volatility. But Paul Malloy, head of US municipals at Vanguard, which manages $260 billion in tax-exempt assets, believes this underperformance has the category looking especially attractive. Munis are “as cheap as it gets,” he says.
The average national municipal bond fund (the largest category of tax-exempt funds) is down 0.6% year to date. Longer-term muni bond funds are down 1.5%, as are high-yield munis, which invest in lower-quality, tax-exempt debt. The losses on muni bond funds contrast with a nearly 3% return on the average intermediate core bond fund. Overall, out of 17 categories of tax-exempt funds tracked by Morningstar, only two are in positive territory. Meanwhile, none of the 15 categories of taxable bond funds is in the red for 2025.
Of the 481 US municipal bond funds with more than $100 million in assets, nearly four-fifths were down in the year to date. The largest municipal bond fund, the $78 billion Vanguard Intermediate-Term Tax-Exempt Fund VWIUX, has lost 0.4% in 2025. The worst-performing fund, the $125 million Redwood Managed Municipal Income Fund RWMIX, is down 4.9%.
Why Are Muni Bond Funds Down in 2025?
Explaining munis’ losses, Malloy starts with valuations: “Munis started the year relatively rich.” One factor pushing valuations high prior to 2025 was the significant growth of separately managed muni accounts, specifically for shorter-term bonds. “Money was getting put to work without judgment of valuation, and that really pushed things higher,” he says.
Another factor is a jump in new issuance following several years of low new bond sales. “In the early part of the year, we saw an increased amount of supply, with a lot of issuers choosing to get out in front of some of the expected uncertainty coming through economic policy by the incoming administration,” says Malloy.
Volatility Spooks the Muni Market
The increased supply was compounded by volatility across the fixed-income market, which prompted outflows from municipal bond funds. “We started to see volatility in the broader fixed-income markets, particularly in the long end of the market,” says Malloy, referring to longer-term maturities. “The extra volatility caused outflows in the municipal ETFs, and that put additional pressure on the high-grade part of the municipal market.”
Investors yanked $381 million from municipal bond funds in March 2025 after adding nearly $6 billion just the month before. Malloy thinks this could reflect a tendency for investors here to be more skittish about downturns. “A typical municipal investor is there for the stability and the income, and once you get a little bit of volatility, they make moves,” he says.
Malloy doesn’t believe that concerns about a potential recession hurting the credit quality of issuers on a wide scale have played a role in the selloff: “We’re not really seeing a long-run fundamental shift that is reshaping the creditworthiness of anything in the municipal market.”
Tax-Exempt Status Is Safe
In late March, Stephen Moore, an informal economic advisor to President Donald Trump, raised the possibility of changing the tax-exempt status of municipal bonds to raise revenue. Malloy says Vanguard sees this as “a very low probability, given how critical a total municipal market is for every state (regardless of political affiliation) and the role it plays in infrastructure.” This news was “part of the noise that we would dismiss,” and likely wasn’t a factor in the municipal bond market selloff or recent outflows.
Munis: Cheap, with Sound Fundamentals
Malloy sees the volatility in the municipal market as an opportunity, not a risk, because he doesn’t believe any of it affects the likelihood of default, at least for investment-grade municipal bonds. “Local governments are in some of the best fiscal shape in decades,” he says. “There’s been responsible use of a lot of fiscal aid. We’re seeing state and local governments with rainy day funds.”
While rising federal deficits may be among the causes of rising Treasury yields, Malloy says municipal bonds are safer thanks to “their disassociation from the federal government, [since] they are their own constitutional entity.” He explains that “the safer place for long end exposure is the municipal market because of the fiscal discipline that’s exercised at the state level.”
In addition, Malloy believes that having come out of 2024 with valuations looking rich, tax-exempt bonds are broadly attractive. For example, the muni bond market is cheaper than it’s been over 95%-99% of the last 15 years. “It basically makes sense for everybody, regardless of tax bracket, to own municipals at this point,” says Malloy.