Morgan Stanley Says It’s Time to Trim Wagers on High-Yield Munis

Investors should reduce holdings of riskier municipal-bond holdings after the strongest rally for speculative debt since 2009, according to Morgan Stanley.

Slowing bond issuance and demand for tax-free securities have pushed investors in the $3.7 trillion market toward higher-yielding assets as benchmark interest rates are close to 11-month lows. Junk-rated local debt has gained about 9 percent in 2014, the strongest start to a year since a 15.7 percent return in the same period of 2009, Barclays Plc data show. The broader market has rallied 5.7 percent this year.

The potential is diminishing for speculative-grade bonds to keep beating the market, said Michael Zezas, chief muni strategist at Morgan Stanley in New York. High-yield debt will probably suffer more when demand slows and municipalities ramp up bond sales, he said.

“For some of these riskier trades that have done well, there are only marginal benefits” going forward, Zezas said in an interview.

Investors holding high-yield munis should “move from overweight to neutral” relative to their benchmarks, Zezas said in a report released yesterday.

Junk securities are ranked below Baa3 by Moody’s Investors Service or lower than BBB- by Standard & Poor’s and Fitch Ratings.

Morgan Stanley joins Citigroup Inc. and Vanguard Group Inc. in questioning the sustainability of the muni rally. The market suffered its worst losses since 2008 last year, and Zezas in December forecast a second year of declines. He said in March that returns were poised to “cool off.”

Zezas said he doesn’t have a specific timeframe on when the high-yield muni outperformance will end.

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