The clientele effect around the turn of the year: evidence from the bond markets

Studying the returns of US Treasury, corporate, and municipal (muni) bonds at the index level over 2004-2020, I find a strong turn-of-the-year effect – low December returns and high January returns – in the high-yield muni index. The investment-grade muni index exhibits a similar but weaker effect. High-yield munis is the only class whose December returns are negatively correlated with year-to-date yield changes. Dominance of highly tax-sensitive households who engage in tax-loss selling, combined with opaqueness, low liquidity, and a small role of ETFs in munis make it difficult to arbitrage away the December price decreases. The investment-grade and high-yield corporate bond indices have abnormally high December returns in years with capital losses. The high-yield corporate index also has abnormally high December returns even in years without capital losses. It represents a change from the findings of prior research and suggests that corporate bond investors exhibit contrarian tendencies in December.