How ETFs Are Driving Growth in Municipal Bonds

Feb 9, 2023

Municipal bond ETFs are on track to double assets under management by 2026 as obstacles to their growth recede, bringing the tax benefits of muni bonds to more investors.

Key Takeaways

  • Ownership of municipal bonds has largely been limited to wealthy investors.
  • The growth of muni ETFs is expanding access to these bonds to a broader group.
  • Evolving regulatory structures and investment models will likely fuel growth.
  • The growth of muni ETFs should have an impact on the muni bond market as a whole. 

Historically, municipal bond ownership has largely been limited to ultra-wealthy investors: It takes significant assets to build a diversified portfolio of muni bonds, and investing in them requires a high level of expertise and management between brokers and clients. But the launch of exchange-traded funds (ETFs) holding an assortment of muni bonds has created an attractive option for investors, combining the tax-exempt fixed income of municipal bonds with the lower fees and diversification benefits of ETFs. It has been 15 years since the launch of muni bond ETFs, but a few factors are paving the way for exponential growth in the coming years.


Morgan Stanley Research expects the value of muni ETFs to double to $200 billion in assets under management by 2026, representing about one-third of the time it took for this asset class to reach $100 billion. While this may seem like a drop in the large bucket of the $4 trillion municipal bond market, the growth of investment in muni bonds via ETFs could have an outsized impact on the market for these assets as a whole by expanding the opportunity for more investors to reap tax benefits.


"ETFs may democratize municipal ownership, increasing the percentage of households that can claim tax-exempt interest" on their income from munis, says Mark T. Schmidt, head of Municipal Strategy at Morgan Stanley Research. “Asset managers should prepare sooner rather than later and lay the framework today for effective product distribution to both retail and institutional client channels."


Setting the Stage for the Next Phase

Almost all classes of ETFs have benefitted from a recent influx of cash, with 85% reporting net inflows since the end of 2020, and muni ETFs are no different. Total assets in muni ETFs have grown by $38 billion since 2020; in 2022 alone, muni ETFs took in nearly $30 billion to account for about 11% of muni fund assets under management. “The funds’ growth could follow the trajectory of equity ETFs, which went from 11% market share in 2008 to account for 32% of equity fund assets under management presently, with an annual compound growth rate of 19%,” says Michael Cyprys head of the Brokers, Asset Managers & Exchanges team at Morgan Stanley Research.  

ETFs may democratize municipal ownership, increasing the percentage of households that can claim tax-exempt interest.

A variety of factors are expected to drive robust growth in muni ETFs.


  • Algorithmic trading is catching on in the muni market and is ripe for expansion, with fewer than 20% of municipal bond trading performed electronically at present, compared with 50% in other fixed-income asset classes. Pricing and trading improvements, along with other potential innovations, should benefit all fixed-income asset classes, and muni ETFs in particular, as a result of deeper and more dependable liquidity in the overall municipal market.
  • The growth of digital financial advisor services is also helping expand the muni ETF market. Today, robo-advisory or digital advisory platforms dominate the top 10 holders of the two largest muni ETFs.
  • Securities and Exchange Commission rule changes in 2019 paved the way for actively managed ETFs, which strategists expect will lead to the tax-free conversion of municipal mutual funds into active ETFs. Also, the expiration of patent protection for ETFs as a share class this year could lead to more generic offerings.
  • Households own more than two-thirds of the muni ETF market, either directly or indirectly, representing a broader base for munis compared with household ownership of equities and corporates. These retail investors will remain the primary drivers of growth.

Democratizing Muni Ownership

Strategists expect muni ETFs to improve the municipals market for investors in a number of ways:


  • ETFs’ lower costs should boost participation in munis by affluent households (those in the 24% to 32% tax bracket), which will fill a gap in market demand. These investors could provide a buffer between demand from banks and ultra-wealthy investors (37% tax bracket), particularly during mutual fund outflow cycles.
  • With time, the added money in muni ETFs could offer hedging and leverage opportunities. The potential creation of ETF-related derivative products could boost market liquidity and encourage more participation by institutional and hedge fund investors.
  • As of 2013, only 2.5% of households claimed tax-exempt interest, but as more investors put money into the asset class by way of muni ETFs, a greater percentage of households could take advantage of munis’ favorable tax treatment.


“This is ultimately a positive for the longevity of the tax exemption—something that active managers should welcome in particular,” says Schmidt.