Charter schools have seen a surge in popularity in recent years, and this growth has created new investment opportunities in the municipal bond market.
Amid the steadily evolving American education landscape over the past decade, charter schools have gained popularity and momentum, emerging as an increasingly alluring option for parents. The COVID pandemic further cemented these schools’ value proposition for many parents, especially in the last few years. We believe charter schools will only continue to gain prominence, especially in communities that have witnessed a significant influx of new families with children due to population migration trends. And with the establishment of more charter schools will come an increase in municipal bond issuance.
At Thornburg, we stand ready to uncover these investment opportunities by diligently selecting attractively priced muni bonds with healthy credit fundamentals. In this article, we share our thoughts on the charter school landscape and why understanding this educational sector’s nuances is critical for identifying opportunities and spotting potential risks.
Parents Are Voting with Their Feet
As seen below, the number of charter schools has more than doubled since the 2005-2006 school year, and students enrolled in them more than tripled from that point to 2020-2021, when they numbered 3.7 million. And according to new data analysis from the National Alliance for Public Charter Schools, since the start of the pandemic, charter schools have seen reliable gains in enrollment. In contrast, public schools have undergone steady enrollment losses.
Charter Schools and Enrollment Have Surged through the Last 20 Years
That Is Likely to Continue Going Forward
Source: National Alliance for Public Charter Schools
Further supporting this trend, numerous states have recently passed laws aimed at bolstering more extensive expansion of charter or private school programs, broadening parents’ access to more educational options for their children. For example, in 2022, Arizona passed comprehensive legislation that made all school-age children eligible for the state’s education savings account, allowing participating families to receive $6,500 annually per child for charter or private schools, homeschools, micro-schools, or other options. Iowa passed similar legislation earlier this year: Over the next three years, all K-12 students will be eligible for about $7,600 annually per child toward alternative schooling costs.
Florida is another excellent example, as the state has been a longstanding champion of charter schools, with currently 1.3 million students attending either charter or private schools. We expect this trend to accelerate especially since Florida passed a house bill that eliminated the financial eligibility restrictions and enrollment caps, allowing even more students to qualify and supporting the expansion of charter programs.
Opportunities and Risks
In the coming years, the consistent expansion of charter accessibility and increasing establishment of new charter schools will ultimately spur more demand to build more school facilities, renovate existing ones, and invest in more educational resources. All of this will inevitably lead to a surge in education-related municipal bond issuance in regions seeing the most demand for charter schools. As depicted below, charter schools have achieved widespread coverage and currently operate in 45 different states. This expansive reach ensures a geographically diverse range of municipal issuances to choose from.
Charter School Reach Is Expansive across Most of the U.S.
Source: National Alliance for Public Charter Schools
Given this vast and diverse opportunity set, we believe a thorough understanding of the strength of related laws and the quality of the charter school is tremendously important. From our perspective, the credit strength of charter school bonds, as with any muni bond, depends on many factors. And four key drivers are at the forefront of our selection process:
- Sound school-management history: We seek schools with a strong track record of effective governance, prudent financial management and budgeting, and substantial cash reserves. Bonds issued by these schools will be in a stronger position to weather enrollment fluctuations or economic downturns that could negatively impact a school’s ability to meet its debt obligations.
- Positive enrollment trends: The extent of student enrollment directly impacts various aspects of a school’s operations, financial stability, specialty program viability, and quality of education. Most charter schools receive funding based on the number of students they serve, so a stable or growing enrollment trend ensures predictable cash flows. Low or fluctuating enrollment, meanwhile, strains resources.
- Robust student body: A school with a large student body (e.g., 1,000 children) will also be better able to offer a broader range of courses and specialty programs, such as advanced placement courses or language immersion programs, compared to very low-enrollment schools (e.g., 300 children). Therefore, monitoring and understanding geographical demand is critical in determining a charter school’s capacity for growth and scale.
- Supportive attitude toward charters: A local government’s approach toward charter schools can have a profound impact on their formation and growth. A supportive governor or legislature is more likely to help facilitate funding and resources by raising payment amounts per student, providing access to grants, and expanding voucher eligibility. By contrast, a more hostile stance can hinder charter school formation and limit enrollment potential through such obstacles as narrower eligibility standards or denial of access to facilities.
While we believe the growth of charter school expansion will open compelling opportunities for muni bond investors, we are also cognizant of the potential risks that may surface. For instance, the rise of charter schools can negatively impact public school funding, especially in communities undergoing a significant migration of students from public to charter schools. This can result in a considerable redirection of state funding away from public districts — which can, in turn, adversely impact the financial stability of public schools and, consequently, impede a district’s ability to repay its debt obligations. We believe it is important to pay close attention to the enrollment trends of public school districts to avoid school bonds with potentially deteriorating fundamentals.
Putting It All Together
Charter school growth shows little sign of slowing, and numerous catalysts continue to fuel that growth as these schools reshape the educational landscape. Amid this expansion, charter school bonds will play an increasingly integral role in the muni bond market. As investors, we believe our diligent credit research process will lead us toward discovering attractively priced bonds with solid credit fundamentals so that our investors can carefully participate in these trends and harness charter school bonds’ promising potential.
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