Intermediate Munis Survive a Challenging February
with Tom Dalpiaz, Managing Director (March 2, 2015)
The double-edged sword of rising rates was in full evidence in February. For existing municipal bond holders, interim values declined somewhat as interest rates rose. On the flip side, by the end of February, municipal bond investors seeking to invest fresh cash had more attractive entry points than what was available in January. A strong employment report and modestly recovering oil prices were the main drivers of higher Treasury bond yields last month. Municipal bond yields followed that general trend higher but their movement was more subdued than Treasuries. The Bank of America/Merrill Lynch 5-10 Year Treasury index had a total return of -1.88% in February while the Bank of America/Merrill Lynch 5-10 Year Muni index returned -0.99%. The more modest volatility of munis can be explained partially by the usual suspects: the tax-exempt nature of the return and the smaller propensity of munis to be used as trading vehicles. These characteristics along with the steady investor demand so far this year have allowed munis, particularly intermediate maturity munis, to weather a negative month such as February in reasonable fashion. Surprisingly, this relatively benign muni behavior has occurred while new issue muni supply has been quite robust. Lower rates throughout January and much of February have caused refundings and new issue supply to increase dramatically, resulting in the highest new issue volume in any January-February period for the past five years. While demand for munis (as evidenced by mutual fund flows) was in positive territory for each week in February, the size of the flows compared to late 2014 was more modest. Seasonally, March and April tend to be months where the demand for munis moderates due to April 15 considerations. If the demand for munis slows down and new supply continues at these robust levels for the next month or two, municipal bond yields may not behave as reasonably as they have so far this year. Not to worry. If seasonal patterns hold, late April and May could provide some buying opportunities.
I mention these seasonal patterns to highlight tendencies regarding muni market behavior at various points in the year. They are useful to keep in mind as investors navigate the muni bond waters. Of course, it’s also useful to have a healthy respect for market surprises that can blow seasonal effects out of the water. This notion gets back to a theme I’ve expressed a number of times in these commentaries. Using your judgment here and there on the speed at which you invest cash is wise. I believe it is also wise to not make it an all or nothing thing or to get too cute about it. Markets will confound us. Even given inscrutable markets, investors are more likely to make progress toward achieving a broad range of investment goals by getting in the game rather than waiting on the sidelines for the perfect moment to run on to the field.
Munis by the Numbers
(Sources: Bloomberg, Barclays Capital)
When does 2.60% = 4.59%? When you are an individual investor subject to the top Federal income tax brackets and you capture a 2.60% yield from tax-exempt municipal bonds.
The 2.60% yield stated above is our conservative estimate of an average yield to maturity for a muni bond portfolio constructed under present market conditions with the following parameters: all investment grade credits, average credit rating A1/A+, all bonds mature within 15 years, average maturity 6 to 7 years, portfolio duration range 3.7 to 4.7 years.
10-year High Grade Muni bond yields as a percentage of 10-year Treasury bond yields: 103% (compared to an average ratio of 98% for the past ten years).
Moving from cash to 5-year munis: +152 basis points (Yield difference on tax-exempt money market funds and Single A rated tax-exempt muni bonds with a 5 year maturity).
Moving from 2-year munis to 10-year munis: +196 basis points (Yield difference on Single A rated 2 year tax-exempt muni bonds and Single A rated 10 year tax-exempt muni bonds).
-0.21% February total return of the Barclays 3-Year Municipal Bond Index (+0.43% YTD, +1.51% for all of 2014)
-0.67% February total return of the Barclays 5-Year Municipal Bond Index (+0.83% YTD, +3.19% for all of 2014)
-0.96% February total return of the Barclays 7-Year Municipal Bond Index (+0.96% YTD, +6.09% for all of 2014)
-1.14% February total return of the Barclays 10-Year Municipal Bond Index (+0.85% YTD, +8.72% for all of 2014)
-1.43% February total return of the Barclays Long Municipal Bond Index (+1.07% YTD, +15.39% for all of 2014)
Thomas P. Dalpiaz has over thirty years of experience in the municipal bond business, with much of that time spent as a portfolio manager for private clients, financial advisors, and institutional investors. He was previously a senior portfolio manager with Advisors Asset Management, Neuberger Berman, Sage Capital Management, and Weiss, Peck & Greer. Prior to becoming a portfolio manager, Mr. Dalpiaz was a municipal credit analyst at Weiss, Peck & Greer, as well as Merrill Lynch and The Bank of New York. Mr. Dalpiaz has had a series of articles published in Forbes and he is the author of “Managing Municipal Bond Portfolios for High Net worth Investors,” a chapter in The Handbook of Municipal Bonds, one of the Fabozzi series of investment books. Mr. Dalpiaz has been quoted in the Wall Street Journal, Barron’s, and in Bloomberg News. He has also been a guest expert on Fox Business News, Bloomberg Television, and NPR’s “On the Money.” Mr. Dalpiaz holds an MBA in Finance and a BA in History, both from Hofstra University. He also holds FINRA Series 7, 24, 63, and 65 licenses.
Granite Springs Asset Management, LLC is a privately held SEC registered investment advisor that specializes in fixed income portfolio management and tactical asset allocation investment strategies for private clients, family offices financial advisers, insurance companies, pension plans, and other institutional investors. The investment philosophy at Granite Springs is based on two principal beliefs; that asset allocation is the most important investment decision and; that disciplined risk management leads to superior returns over time.
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