It's not only residents of high-cost coastal states that are plowing into municipal bonds as a haven from the new deduction limits. It's happening in Minnesota, too.
Pinched by the new cap on state and local tax deductions, Minnesota residents are buying up municipal debt to reduce their tax burden because the securities pay interest that's exempt from federal and state taxes. New York and California investors have gotten plenty of attention for helping drive a $20 billion influx of cash into municipal mutual funds in 2019. But there's also more interest in the asset class by investors living in smaller high-tax states, asset managers say.
Minnesota had the fourth-highest top state income-tax rate in the country last year at 9.85 percent, according to TurboTax. That's driven more interest in Eaton Vance's $135 million Minnesota Municipal Income Fund, said Craig Brandon, co-director of state and local government bond investments at Eaton Vance Management. Of the company's 17 state-specific municipal mutual funds, 16 have seen positive net inflows in 2019.
"Municipals are almost like the last great tax haven left," he said.
Doug White, co-manager of the Columbia Minnesota Tax-Exempt Fund, said he's seeing more interest in municipals from Minnesota residents. That could "powerfully" increase as more people complete their taxes and realize the impact of the limit on deductions, he said.
"A state like Minnesota with a low population doesn't make the news, but we're a very high-tax burden state and there's always been a strong demand for munis as a result," he said.
Eaton Vance and Columbia declined to break out flow figures into their funds. Minnesota state open-end and exchange-traded municipal funds have pulled in $90 million in the first two months of 2019, far more than the $17.6 million they attracted in the same period of 2018, according to data compiled by Morningstar.
They've even attracted more than municipal funds focused on New Jersey and Connecticut, both high-tax states that are affected by the limit on state and local tax deductions. New Jersey funds have drawn in some $71.5 million in net inflows during the first two months of the year, while Connecticut funds have seen more than $12 million in outflows, the Morningstar data show.
California long and intermediate mutual funds have pulled in $1.2 billion during the first two months of the year, and New York long, short and intermediate funds have pulled in $382 million, according to the data.
James Iselin, a managing director at Neuberger Berman Group, said he's seeing renewed interest in municipals "across the country," driven by the new cap on deductions as well as expectations for a more dovish Federal Reserve.
"Minnesota residents have always loved their Minnesota munis," he said. "The state tax rate is high and there's some good credits there. When the SALT cap kicked in in 2018, just as it drew more California residents to California bonds and New Yorkers to New York bonds, the same effect is happening there."
Still, Minnesota's 5.6 million residents face a smaller market of debt to invest in than residents in other high-tax areas. The state only had about $8.2 billion in net tax-supported debt in 2017, while California had almost $87 billion and New York $60.6 billion, according to Moody's Investors Service.
White said it can be tough to find deals that offer extra yield, with Minnesota rated AAA by S&P Global Ratings. Its 10-year state general-obligation debt trades close to other top-rated securities, according to data compiled by Bloomberg.
School districts, a dominant type of Minnesota debt issuer, also tend to be high quality credits, he said. "It's a challenge," he said.