In the complex world of municipal bonds, there exists a niche market that is gaining traction among investors – charter school municipal bonds. According to Dan Close, the head of municipals at Nuveen, charter schools represent a small but promising sector within the education muni bond landscape. With increasing demand for these schools, there is a projected strong supply of charter school municipal bonds in the market. Close points out that investors in the highest tax bracket can benefit from a tax-equivalent yield of nearly 8% from these bonds, making them an attractive investment option.
Charter school bonds are typically used to fund construction, renovation, or the purchase of school facilities. One key advantage of these bonds is that the interest is exempt from federal tax, and in some cases, they are also free from state taxes. Despite charter schools not being a new concept, there has been a noticeable uptick in demand due to the COVID-19 pandemic and favorable legislation in support of school choice in various states. As of now, there are approximately 8,000 charter schools in the United States serving 3.7 million students, with an increasing number of students opting for charter schools over traditional K-12 public schools.
Within the broader $580 billion K-12 education muni bond sector, charter schools make up a substantial portion, amounting to about $33 billion. While issuance faced a decline in recent years due to rising interest rates, there is a positive outlook for 2025, with an anticipated $4 billion to $5 billion in new issuance. Close highlights the unique risk-reward profile of charter school bonds, noting that while they carry a higher risk due to the inability to levy dedicated taxes, they offer a significantly higher yield compared to traditional K-12 education munis.
Unlike traditional K-12 education munis that are typically investment grade with ratings of AAA and AA, most charter school municipal bonds are not rated. This is primarily because many charter schools are still in their early operating stages, making it unlikely for them to receive favorable ratings from agencies. As a result, a significant portion of charter school bonds fall below investment grade, with some considered high yield. However, investors are drawn to these bonds due to the potential for credit improvement as the schools expand and enhance their facilities.
While the allure of higher yields may be tempting, investors are advised to conduct thorough research before diving into charter school municipal bonds. Nuveen employs four charter school analysts to assess the viability of schools for long-term success. Factors such as the school’s location, academic performance, unique curriculum, financial management, and legal provisions are crucial in determining the potential success of a charter school. Some of the names held in Nuveen’s High Yield Municipal Bond Fund include The Academy Charter School in Hempstead, New York; Norton Science and Language Academy in San Bernardino, California; and Community of Peace Academy in St. Paul, Minnesota.
As the landscape of education financing evolves, charter school municipal bonds present a compelling investment opportunity for discerning investors. With the potential for attractive yields, tax advantages, and the opportunity to support the growth and development of charter schools, these bonds offer a unique avenue for portfolio diversification. However, it is essential for investors to conduct thorough due diligence and engage with experienced analysts to navigate the complexities of this specialized sector. By carefully evaluating the risk-reward profile and identifying promising charter schools, investors can capitalize on the growing market for charter school municipal bonds.