Investors in U.S. `Keep Their Heads’ After S&P Downgrades Municipal Bonds
Individual municipal-bond investors aren’t fleeing the market after Standard & Poor’s lowered the credit rating of thousands of bonds.
The ratio of buy orders to sell orders, a measure of investor demand, was 2.5 for municipal-bond trades on the BondDesk Group LLC platform yesterday, meaning there were more buyers than sellers, said Chris Shayne, senior market strategist for the group, a bond marketplace that works with dealers, advisers and discount brokers. That ratio showed demand was about normal and up from earlier in the week when demand was “substantially” weaker than normal, said Shayne, who’s based in Mill Valley, California.
Investors may not be dumping their bonds in part because they’re more focused on the underlying ability of issuers to repay principal and coupons, said Tom Spalding, who oversees about $10 billion in municipal securities in mutual funds and closed-end funds at Nuveen Investments Inc. in Chicago.
“They’re taking a longer-term view,” Spalding said. “The overwhelming evidence is that municipal credit is still a relative safe haven for investors.”
Flows this week have been mixed in the mutual funds Spalding manages with “modest” inflows to short-term municipal-bond funds and similar outflows from long-term funds, he said.
“We have not seen the collateral damage in muni land,” said Marilyn Cohen, president of Los Angeles-based Envision Capital Management Inc., which manages $328 million in fixed- income assets for individuals. “People were braced for it. They understood it does not mean that the credit metrics have deteriorated immediately.”
The Dow Jones Industrial Average fell about 520 points, or 4.6 percent yesterday, to the lowest level since September 2010. Standard & Poor’s assigned AA+ ratings, the second-highest investment-grade rating, to about 11,500 municipal securities this week, according to data compiled by Bloomberg. The affected bonds generally are tied to the federal government, which lost its AAA long-term credit rating from S&P on Aug. 5.
“Getting in and out of the municipal market causes its own friction, and I’m not going to do it willy nilly because everyone is running around with their heads cut off,” said New York-based Thomas Dalpiaz, who oversees $280 million as senior vice president of Advisors Asset Management Inc. “It’s my job to keep my head when everybody is losing theirs.”
Wait and See
Individual investors generally don’t sell bonds as quickly as they may sell stocks in reaction to bad news, said John Hallacy, head of municipal research at Bank of America Merrill Lynch in New York.
“They might wait a couple of days to see how things shake out before they decide what they are going to do, and they also need time to talk to their financial advisers,” he said.
Investors pulled about $14.5 million out of municipal-bond mutual funds on Tuesday, the seventh straight day of flows from the funds, according to data from TrimTabs Investment Research. There was about $861 million in total withdrawals from U.S. municipal-bond mutual funds in the week ended Aug. 3, before the downgrade, and that was the greatest weekly outflow since April, according to Lipper US Fund Flows.
Mutual-fund investors took money out of the funds for six straight months beginning in November 2010, according to data from Chicago-based Morningstar Inc. (MORN), including $13 billion in outflows in December, the month when analyst Meredith Whitney forecast that there could be 50 to 100 “sizable” municipal- bond defaults. From May through July investors were adding money to the funds, Morningstar said.
“There’s no parallel,” in current fund flows to the outflows municipal-bond funds experienced in late 2010, said Spalding.
Municipal bonds fell 0.04 percent this week through yesterday, as measured by the Bank of America Merrill Lynch Municipal Master Index. Prerefunded municipal bonds, or those backed by Treasury bonds held in escrow, gained 0.07 percent, as measured by the Bank of America Merrill Lynch Municipal Prerefunded Index.
Some investors may be holding on to municipal-bond investments because there are few other safe havens available, said Robert Kane, founder and chief executive officer for BondView, which provides bond-market data for advisers and individual investors.
“There’s a kind of tug-of-war going on here with people wanting muni bonds and thinking longer term, and people thinking ‘Gee, I want to get out,’” he said. “But if you do get out, where do you go?”
Signs of Selling
There were some signs of selling following the U.S. downgrade. Shares of the iShares S&P National AMT-Free Bond Fund, an exchange-traded fund, closed Monday at a 1.77 percent discount to its net asset value, or the underlying value of its holdings, the largest discount for the fund since December 2010, according to data compiled by Bloomberg.
That discount may be because shares of the exchange-traded fund are more liquid than bonds sold over-the-counter, so market movements may show up in its shares before they are reflected in prices of the underlying bonds, said Matt Tucker, head of fixed- income investment strategy for BlackRock Inc. (BLK)’s IShares unit. On Wednesday the shares closed at a 0.77 percent discount to net asset value.
No New Issuance
Closed-end municipal-bond funds traded Monday at an average discount of 8.39 percent to their net asset values, the largest discount since April 2009, said Cecilia Gondor, executive vice president at Miami-based Thomas J. Herzfeld Advisors Inc. The discount narrowed to 5.48 percent at the close of trading Wednesday.
Declining new issuance has limited the supply in the municipal-bond market, and many investors value the tax-exempt income provided by the bonds, said Josh Gonze, a co-portfolio manager who oversees $6.5 billion in municipal-bond assets at Thornburg Investment Management Inc. in Santa Fe, New Mexico. The funds he manages have not seen any significant inflows or outflows this week, Gonze said.
There was $141 billion in municipal-bond issuance in 2011 through July, compared with $216 billion in the first seven months of 2010, said Thomas Doe, chief executive officer and founder of Concord, Massachusetts-based Municipal Market Advisors.
Bonds issued by providers of essential services such as utilities should be less vulnerable to the effects of any future cuts in government spending, said Howard Cure, director of municipal-bond credit research for Evercore Wealth Management LLC in New York, which oversees about $2.9 billion.
Evercore recently purchased bonds issued by the Puerto Rico Electric Power Authority that mature in 2019 at a yield of 4.04 percent. Interest from Puerto Rico municipal bonds is generally exempt from state and local income taxes for residents of any state.
“We think that diversification is our best defense,” said Elizabeth Fell, head of U.S. fixed-income strategy at Barclays Wealth, which manages about $272 billion. Fell, who’s based in New York, is advising clients to hold general-obligation and certain revenue bonds.
There may be better opportunities among high-yield municipal bonds, which individual investors may not be able to analyze, said Jason Thomas, chief investment officer at Aspiriant, which manages about $7.5 billion.
No Flashing Sign
“The municipal-bond market is driven by the retail investor, who is drawn to the apparent safety of general- obligation municipal bonds,” said Los Angeles-based Thomas.
About 37 percent of municipal bonds are held directly by households and 32 percent is held by mutual funds, according to U.S. Federal Reserve data.
Bond investors who purchased individual bonds with a long- term time horizon generally should not sell, Kane said. They should selectively trim holdings with very low interest rates or long time horizons, and bonds likely to be downgraded.
“The fundamentals aren’t flashing a red warning sign,” he said.