Biggest ETF at Record Discount Signals July Rally: Muni Credit
The biggest exchange-traded fund tracking the $3.7 trillion U.S. municipal market is selling at its deepest discount ever to the value of its assets. That may be a sign that tax-exempt securities are getting cheap enough to rekindle buying.
The $3.5 billion iShares S&P National AMT-Free Municipal Bond Fund, known as MUB, touched $100.42 (MUB) in New York trading today, the lowest since April 2011, data compiled by Bloomberg show. The move reflects yields on benchmark 10-year local debt climbing as high as 2.68 percent , the most since October 2011.
MUB’s losses echo those in the market for Treasuries, where yields on securities maturing in 10 years jumped to 2.66 percent (USGG10YR), the highest since 2011, after Federal Reserve Chairman Ben S. Bernanke said the central bank may moderate purchases of government and mortgage debt in 2013 and end them around mid-2014 if the economy performs as forecast. Yet demand for munis may rebound in July as investors deploy cash from principal and interest payments, said Matt Dalton of Belle Haven Investments Inc. in White Plains, New York.
“Once we get past the Fourth of July holiday, we’ve got a chance of seeing some stability come into this market because of the reinvestment needs,” Dalton, who manages $1.6 billion of local debt, said in a telephone interview.
Investors have been dumping munis even though they have gained in 21 of the past 24 years in July, according to Bank of America Merrill Lynch data. The selling last week helped push MUB to a discount of about 2.86 percent to its net asset value, the steepest since the fund began in September 2007, Bloomberg data show.
While ETFs are similar to mutual funds that track an index of equities, bonds or commodities, they are bought and sold on stock exchanges and their prices may rise or fall more than the value of the assets they hold.
“The move down in price has been so fast that the net asset values haven’t yet been able to catch up with it,” said Matt Fabian, a managing director at Concord, Massachusetts-based Municipal Market Advisors.
Investors are rejecting local debt as they see the value of those securities decline, said Dalton. The S&P National AMT-Free Municipal Bond Index, a measure of the broader market, fell 1.07 percent June 20, the biggest one-day drop since December 2010, according to Standard & Poor’s data.
The plunge follows investors pulling $1.86 billion out of U.S. muni mutual funds from Jan. 1 through June 19, Lipper US fund Flows data show. That was the first time since 2011 that holders withdrew money from the funds for the first 24 weeks of a year.
This year’s outflows will push yields high enough to bring investors back to munis, Fabian and Dalton said. Even an increase of 0.2 to 0.3 percentage points could renew buying, Dalton said.
“When investors take a step back and the panic comes out of their emotions, and you apply a 39.6 percent federal tax rate to some of the yields on munis right now, you forget how attractive they are,” Dalton said.
For investors in the highest tax bracket, 39.6 percent, the benchmark 10-year muni yield is equivalent to a taxable return of 4.4 percent. That’s double the 2.2 percent dividend investors earn on the Standard & Poor’s 500-stock index, Bloomberg data show.
Demand for tax-exempts may increase after Independence Day because investors will need to redeploy, Dalton said. Muni holders are set to receive $128 billion of principal and interest payments in June, July and August, $16 billion more than last year, according to Bank of America.
In the meantime, Dalton and Ebby Gerry, who helps oversee $15 billion of munis at UBS Global Asset Management in New York, say they’re taking advantage of rising yields to buy at cheaper prices as the supply of debt in the secondary market has increased.
Mutual funds and other institutions offered as much as $1.27 billion of state and local debt for sale last week, more than double the one-year average of $551 million, Bloomberg data show.
“It’s like a buffet, there’s so much,” Dalton said. His firm is concentrating on buying higher-grade municipals because that’s what mutual funds tend to sell when yields rise, he said.
While the muni market has been “brutal,” it will turn around in the next few weeks, Dalton said.
“No market trades in one direction forever,” Dalton said. “At some point, this bond market will get its legs underneath it. The opportunities that are presenting themselves today will be quickly snapped up.”
Illinois, the lowest-rated state, will get a chance to test investor demand June 26 when it offers $1.3 billion in general-obligation bonds, its biggest sale since May 2012, after lawmakers were unable to agree on a plan to reduce an unfunded pension obligation of almost $100 billion.
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