Pimco Local Buying Signals Longest Rally Prolonged: Muni Credit
Bill Gross keeping his municipal- debt holdings in September at the highest since at least 2006 lends confidence to a market on a pace to beat Treasuries for a second straight year.
Gross, 68, directed 5 percent of the $278 billion Total Return Fund, the world’s biggest bond fund, to state and local debt last month. It’s the first time he’s held that high a percentage of munis in consecutive months since at least 2006, according to data released yesterday by Gross’s firm, Pacific Investment Management Co.
Bets on the $3.7 trillion muni market are paying off as local borrowings are poised to out-earn Treasuries this year on an absolute basis and when adjusted for volatility. City and state debt has returned 3.7 percent in 2012 after accounting for price swings, compared with 0.6 percent for Treasuries, data compiled by Bank of America Merrill Lynch and Bloomberg show. It would be the second straight year for tax-exempts to beat federal securities, the longest stretch since 2006.
“The risk-adjusted returns that we’ve had this year is one of the key factors as to why we’ve been buying them as a firm,” said Joe Deane, who helps manage $62 billion as head of muni investments in New York at Pimco, in an Oct. 9 interview. “We’ve been buying them pretty much across the board and it’s because we felt it was one of the safer, cheaper spread asset classes.”
Munis are among fixed-income segments to benefit from Gross’s move to cut back on Treasuries, which he reduced to 20 percent last month, the lowest since October 2011, on concern that record U.S. government borrowing will lead to quicker inflation. Mortgages are his biggest holding, at 49 percent.
The fund, based in Newport Beach, California, has returned 9.3 percent this year, beating 97 percent of its peers, data compiled by Bloomberg show. It is staging a rebound from 2011, when it outperformed 30 percent of that group.
Gross is adding to state and city debt as investors seeking a haven from Europe’s financial crisis have turned to munis, pushing yields to 45-year lows. Muni mutual funds have added assets for 25 straight weeks, the longest span since March 2010, according to Lipper US Fund Flows data.
“Pimco continues to see value in high-quality municipal bonds,” according to an August fund commentary. “And we retain our preference for essential-service revenue bonds such as water and sewer, power, and airports.”
Mark Porterfield, a Pimco spokesman, didn’t respond to an e-mail and a voice message seeking comment yesterday.
Before the past two months, Gross also held 5 percent in munis in November 2011. He held no munis from March to May of 2007.
Tax-free debt is extending a rally even after three California municipalities declared bankruptcy since June and as states face potential federal-spending reductions set to start in January unless Congress acts.
Still, the default rate for muni debt is lower than that for corporate bonds. From 1970 to 2011, an average of 0.08 percent of investment-grade munis that were sold a decade or more earlier defaulted, compared with 2.61 percent for investment-grade company bonds, according to Moody’s Investors Service.
“On an after-tax basis, municipals still provide a tremendous amount of yield for unit of default risk,” said Matt Fabian, managing director at Concord-Massachusetts-based Municipal Market Advisors.
The Total Return Fund invests in government, mortgage and investment-grade company fixed-income securities. Pimco, a unit of Munich-based insurer Allianz SE, managed $1.82 trillion of assets as of June 30, including a selection of municipal-bond funds.
In the past four to five months, Deane’s muni portfolios have grown from $55 billion, he said.
Deane looks for munis maturing in 14 to 20 years and tends to prefer essential-service revenue bonds to general- obligations. He does invest in state and larger city general obligations while avoiding smaller municipalities and school districts, which typically rely on property taxes for repayment.
“It’s very unlikely that assessed valuations have bottomed,” Deane said, talking about property assessments. “And that’s what you really get paid on.”
In trading yesterday, yields on 10-year bonds rated AAA were little changed at about 1.66 percent, data compiled by Bloomberg show. The index touched 1.63 percent July 27, the lowest since at least January 2009, when data collection began.
Following are pending sales:
WISCONSIN plans to offer $303 million of general-obligation bonds through competitive bid as soon as Oct. 17, data compiled by Bloomberg show. Proceeds will help finance construction of highways and buildings and acquire land and equipment, according to offering documents. (Added Oct. 11)
DISTRICT OF COLUMBIA is set to borrow $675 million of general-obligation tax-revenue anticipation notes as soon as next week, according to Moody’s Investors Service. (Added Oct. 11)
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