The muni market seems healthy. Other than the cases where budgets are exploding, the market as a whole has characteristically low yields and looks stable, especially because of excess investor demand from the recent tax changes. However, there are structural concerns about the market. Nuveen and Vanguard have come to dominate the market through their funds, sucking up to two-thirds of all the Dollars flowing into the market in the last decade. This is because investors have been increasingly buying muni funds, not individual securities. However, according to UBS, this is a big risk. “When everyone runs for the exit at the same time…no one wants to be the buyer of last resort … The concentration in large municipal asset managers will have ramifications during volatile times in that it will make the swings greater one way or another”.
FINSUM: Everyone has been warning about big runs on fixed income funds in a market downturn, but evidence of such has yet to materialize.
The muni bond market is in a difficult place for investors. Demand is far outstripping supply, which means prices are high and yields low, leaving investors few opportunities to find value. However, few does not mean none, so here are some places to find good value municipal bonds. Airport muni bonds can be a good choice, as they tend to fair well in recessions and have very defensible funding sources (e.g. state and local governments). Toll-road bonds are another good choice, as they have very strong credit characteristics (only two have defaulted since 1970). Toll roads in San Francisco, New York, Oklahoma, and Maine are particularly good bets as there are few options for drivers to avoid them.
FINSUM: These seem like well-thought out and defensible choices.
If you are looking for for a safe place to earn some yield in munis, look to Texas. Specifically, the Texas Permanent School Fund, a heavy weight in the muni market that backs $80 bn of debt. The fund has a triple A rating from multiple agencies and is one of the safest bets in the market. The bonds average a 1.9% yield, which is quite strong for the muni market, especially considering the average triple A only yields 1.7%.
FINSUM: This seems like a very strong credit, and one with a surprisingly good relative yield.
Investors beware, the muni bond market has gone through some dramatic moves over the last year, and the market looks like it might be headed for a downturn. Changes to the US’ tax policy have caused massive inflows to muni bonds as investors try to minimize their taxes. This has caused yields to plunge and spreads to Treasuries to widen. The average ten-year muni yield is now just 1.965% versus 2.6% in 10-year Treasuries, the widest gap since at least 2009. Munis in high tax states have plunged even further, with a recent California issuance having a yield of just 1.73%. One portfolio manager warns investors that they need to be responsive, saying “The best place for investors to be is shorter duration, higher-quality credit, so when opportunities present themselves, they have the flexibility to take them … You can’t really set it and forget it”.
FINSUM: This is a hard situation to call. On the one hand, the rapid fall in yields is worrying and the market seems overbought, but on the other hand, you have somewhat artificial demand being created by the government, which makes the behavior less risky and more sustainable in our view.
There is a LOT going on in fixed income markets right now, and for the most part, those developments are confusing. Treasury bonds had a huge rally, and then a little pull back, on worries about the economy. But at the same time, the riskiest bonds—high yield—have been doing very well even though they are the most likely to suffer in a recession. So where should investors have their money in fixed income? Long-dated municipal bonds might be one good idea. Advisors will be well aware of their tax exempt status, but what is interesting right now is that they appear a relative discount. 30-year munis have yields over 3%, well above Treasuries, making them look like a relative steal.
FINSUM: These seem like a good buy right now, especially with the rate outlook being so dovish.
Here is an interesting fact for investors—municipal bonds tend to hold up well during periods of rising rates. The underlying tax benefits of the bonds mean their demand is well insulated even in such periods. The question is where to commit capital. Well, year-end tax loss selling is creating some interesting opportunities in closed end muni funds, says BlackRock. Some funds are selling at significant discounts to the NAVs, sometimes 10% or more. These funds tend to bounce back in the new year, which is called the “January effect”. The discount to NAV allows one to gain even if the prices of the underlying assets don’t budge.
FINSUM: Closed end muni funds look like a great place for some bargaining hunting until the end of the year.