Gross Expands Local Bonds to the Most in Five Years: Muni Credit

Bill Gross
Bill Gross, co-chief investment officer of Pacific Investment Management Co., speaks during an interview in New York. Photographer: Scott Eells/Bloomberg

Pacific Investment Management Co., which runs the world’s largest bond fund, has boosted holdings of U.S. municipal debt to the most in more than five years and may buy more.

Adding securities that outperformed Treasuries, stocks and commodities last year may bolster Bill Gross’s $244 billion Total Return Fund, which lagged behind others in 2011. It returned 4.16 percent compared with the average 4.78 percent of its peers last year, according to data compiled by Bloomberg.

State and local borrowers in the $3.7 trillion municipal market withstood the lengthiest recession since the 1930s as they cut spending to close deficits and tax revenue rose for eight straight quarters to Sept. 30, the longest string of gains since 2008, the Census Bureau said Dec. 20. The “hundreds of billions of dollars” of defaults predicted by bank analyst Meredith Whitney didn’t happen.

“Our portfolio managers around the country felt that it was an area that was worth taking a look at and investing in,” said Joe Deane, who manages $16 billion as head of municipal-bond investments at Pimco in New York. “We just felt that on an overall relative-value basis, that it was really one of the most attractive asset classes out there.”

Top-rated 30-year tax-exempt bonds yielded as much as 137.7 percent of similar-maturity Treasuries in November, the most since April 2009. That made their tax-sheltered income more valuable to high-earning individuals than the taxable interest of U.S. debt.

Historic Highs

“Their yields of 5 to 6 percent are near historically high ratios to Treasuries,” Gross said in his January investment outlook. “They do, however, entail risk -- not only volatility but occasional default risk.”

That’s not a prediction of widespread defaults as suggested by Whitney, Gross wrote, “but simply a recognition that you usually get what you pay for.”

Gross said in his outlook that investors should consider Treasuries, long-term inflation-indexed U.S. debt, high-grade corporates, bank debt and municipal securities to hedge the risk that policy makers are unable to foster growth and inflation accelerates.

The Total Return Fund, which has beaten 97 percent of its peers in the past five years, invests in government, mortgage and investment-grade company fixed-income securities. It aims for income and capital preservation. Municipal securities accounted for 5 percent, or $12.2 billion, of its holdings at the end of November, according to figures on Pimco’s website.

That’s up from 4 percent in the 13 previous months and the biggest allocation since at least 2006, according to an analysis of the figures by Bloomberg.

Profitable Market

The increase came as the tax-exempt market earned 11.2 percent in 2011, according to Bank of America Merrill Lynch indexes tracking prices and interest income. That beat 9.3 percent for Treasuries and 7.2 percent for company debt. The Standard & Poor’s 500 Index of stocks was unchanged and the S&P GSCI Spot Index of commodities rose 2.1 percent.

Even when adjusted for the risk of price volatility, municipal bonds beat Treasuries, investment-grade corporate debt and junk bonds, according to data compiled by Bloomberg.

Pimco, based in Newport Beach, California, was able to take part in 2011’s rally even though it bought munis late in the year, said Deane, who joined in July after co-heading the tax-exempt department at Western Asset Management Co.

“We got an awful lot of it in the fourth quarter,” Deane said in a telephone interview Jan. 6.

Possible Increase

Pimco’s total municipal holdings are $55.8 billion, Deane said. The firm, a unit of Germany’s Allianz SE, Europe’s biggest insurer, may increase munis in the Total Return Fund in 2012 based on how the securities compare with other asset classes, he said.

“It will depend on what’s going on in the rest of the world,” Deane said. “And do we get volume that will come back in and get us back to those kind of interest-rate levels that we found so attractive a month or two ago.”

Yields on benchmark 30-year municipals increased to 3.94 percent on Dec. 2, the highest in four months, according to Bloomberg data. That’s as states and cities sold $31.8 billion of debt in October and $30.3 billion in November, the busiest months of 2011, according to Bloomberg data. The 30-year yield was 3.71 percent Jan. 6.

Another buying opportunity may occur if states and cities increase borrowing to take advantage of low interest rates, Deane said. Fifteen states have reported revenue exceeding projections, according to the National Association of State Budget Officers. Yields would then rise to attract buyers, he said.

More Volume

“Probably by February or March, you’re going to see, especially at these interest-rate levels, an increase in new-issue volume,” Deane said. “That will help balance out the market.”

Municipals will probably return 6 percent to 7 percent this year, less than last year, Deane said.

“If you get your coupon and an extra 100 to 150 basis points in terms of total return, I think from where we are right now, we’d be pretty comfortable with that,” he said.

Following are descriptions of coming sales of municipal debt:

COLORADO is set to borrow $230 million of tax- and revenue-anticipation notes as soon as tomorrow. The sale will provide interest-free loans to school districts. The notes are rated SP-1+, S&P’s highest short-term investment grade. (Added Jan. 9)

METRO WASTEWATER RECLAMATION DISTRICT, COLORADO, which serves 1.7 million people in and around Denver, plans to sell $380 million of sewer-improvement bonds through competitive bid on Jan. 11, according to offering documents. The bonds are rated Aa1, Moody’s Investors Service’s second-highest investment grade. (Added Jan. 6)

ALLEGHENY COUNTY, PENNSYLVANIA, the second-most-populous county in the state and home to Pittsburgh, will borrow as soon as this week $175 million of tax- and revenue-anticipation notes. The debt matures July 2012 and will help the county meet spending needs until it receives tax collections, according to sale documents. The notes will price competitively. The deal is rated SP-1+, S&P’s highest short-term investment grade. (Added Jan. 6)



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