Municipal investors looking for a getaway from the lowest yields in a generation are favoring Guam and the U.S. Virgin Islands over Puerto Rico as their destination of choice.
Issuers from Guam, the U.S. island about 4,000 miles (6,436 kilometers) west of Hawaii, have gained 11 percent this year, more than any state or territory, Barclays Plc data show. The Virgin Islands have earned 10 percent. Guam exceeds the return on Puerto Rico debt by the most since at least 2001. It is also beating the $3.7 trillion municipal market by the most in more than a decade and for the fourth straight year.
The extra yield on Puerto Rico securities is close to the highest since February amid concern that the commonwealth will struggle to improve its pension system, which has a funding ratio lower than all 50 states. Meanwhile, Guam has gained from renewed hotel building and the Virgin Islands from Diageo Plc starting to produce rum there for U.S. consumers.
“Guam and the Virgin Islands were both going to benefit from the noise getting worse in Puerto Rico,” said Robert DiMella, co-head of MacKay Municipal Managers, which oversees $6.8 billion of local debt. The firm’s New York fund has about 11 percent of its holdings in Guam and beat 96 percent of its peers the past three months, data compiled by Bloomberg show.
Puerto Rico’s general-obligation rating was cut two levels today by Moody’s Investors Service to Baa3, its lowest investment grade. The territory’s debt per capita is 10 times the U.S. average and its pension system has assets equaling 6.8 percent of estimated payments, the weakest in the nation.
Republican Governor Luis Fortuno, who cut payrolls by 17 percent to reduce deficits, lost his re-election bid in November to Alejandro Garcia Padilla, the Popular Democratic Party candidate.
The island’s fiscal woes have caused Puerto Rico bonds to trail a rally in lower-quality debt, even as investors seek the higher yields of riskier assets with muni interest rates at 47-year lows. The yield gap on the territory’s revenue-backed securities has grown 50 percent since March. Bonds from Puerto Rico have earned 6.5 percent this year, Barclays data show.
As DiMella reduced Puerto Rico securities, he added debt such as Guam general-obligations, which have a rating of B+ from Standard & Poor’s, four steps below investment grade.
A Guam Power Authority issue in October showed the extra return available. The offer included bonds maturing in 2034 and yielding 4.35 percent, about 1.7 percentage points above benchmarks of the same maturity, data compiled by Bloomberg show. S&P graded that segment BBB, two steps above junk.
“People are looking for where performance can come from, and it comes from buying the higher-yielding bonds and the higher-duration bonds,” said Tom Weyl, director of municipal research at Barclays in New York.
The market for state and city debt has earned 7.7 percent this year, Barclays data show. Guam’s index has an average rating three levels below the broader market’s grade, and the Virgin Islands index is five steps lower.
The two territories have benefitted from the relative scarcity of their debt. Puerto Rico and its agencies have sold about $16.8 billion over the past two years, data compiled by Bloomberg show. That compares with $775 million from Guam and $441 million from the Virgin Islands.
Puerto Rico has a population of about 3.7 million, compared with about 160,000 for Guam and 106,000 for the Virgin Islands, U.S. Census Bureau data show.
Investing in Puerto Rico is “quite different just because of the size of our economies, and we are a very active issuer,” Juan Carlos Batlle, president of the Government Development Bank for Puerto Rico, the commonwealth’s financing arm, said in an interview.
Tourism represents about 30 percent of Guam’s economy, according to Joe Arnett, treasurer of Guam’s Chamber of Commerce. The territory had about 1.3 million visitors in the 2012 fiscal year, 100,000 more than two years earlier, according to the Guam Visitors Bureau.
The increase has encouraged Dusit Thani Pcl, a Thai hotel operator, to take on management of the 417-room Dusit Thani Guam, set to open next year.
The U.S. Virgin Islands, purchased from Denmark for $25 million in gold in 1917, relies 70 percent on tourism for its economy, said Donna Christensen, the territory’s congressional delegate, in a telephone interview from Washington. Its other major business activity is rum production, she said.
That includes a distillery for Captain Morgan that left Puerto Rico for St. Croix beginning this year, Christensen said. The Virgin Islands Public Finance Authority sold $250 million in 2009 to help Diageo, which is based in London, finance the rum venture.
The islands aren’t without their fiscal strains. A 350,000-barrel-a-day Hovensa LLC refinery, a partnership of Hess Corp. and Petroleos de Venezuela SA, closed on the Virgin Islands in February. The enterprise had been the area’s biggest private employer and the departure resulted in what Christensen called “some very challenging times.”
Relying on tourism leaves both Guam and the Virgin Islands vulnerable to swings in the economy and weather, which justifies their lower ratings, according to S&P. The earthquake and tsunami in Japan last year limited growth in Guam’s tourism revenue, Arnett said.
Yet investors such as MacKay’s DiMella and Franklin Advisers’ Rafael Costas are still betting on the islands’ essential-service debt.
“They’re small islands without a whole lot of spectacular growth, but they need water and electricity like everybody else,” said Costas, co-director of munis at San Mateo, California-based Franklin, which oversees $85 billion of local debt. “They finance it and they make good on it -- they’ll just never be AA credits.”