Nuveen’s 21% Return Leads 2014’s High-Yield Frenzy: Muni Credit

By Brian Chappatta

(Bloomberg) –- Nuveen Asset Management’s California and national high-yield municipal-bond funds earned the biggest tax-free returns in 2014, leading a broad rally in risky debt as investors combatted an unexpected drop in interest rates.

The Chicago-based company’s California High Yield Municipal Bond Fund beat all open-end peers focused on state and city debt in 2014, gaining 21 percent, data compiled by Bloomberg show. Its $10.6 billion flagship high-yield fund ranked second, rallying 18.8 percent as it lured $2.06 billion in new investor cash.

Nuveen’s gains reflect a strengthening U.S. economy: With default rates at the lowest since at least 2010, the company’s bets on land-backed deals and riskier sales from hospitals and charter schools paid off, said John Miller, who runs the fund and oversees about $100 billion of munis as co-head of fixed income. Investors also rewarded the company for avoiding almost-ubiquitous debt from junk-rated Puerto Rico, whose electric utility may force investors to absorb losses in a restructuring.

“A lot of the outperformance in 2014 is reflective of hanging onto the right credits and the right types of bond structures in 2013,” Miller, 47, said in an interview.

The difficulty of 2013 created inexpensive opportunities to purchase bonds with better credit, causing the funds to outperform in 2014, he said.

Unpredicted Returns

High-yield muni debt lost 6.2 percent in 2013, the worst performance in at least four years, Bank of America Merrill Lynch data show. It fell as Detroit’s bankruptcy filing and Puerto Rico’s growing fiscal crisis exacerbated fears of rising interest rates.

The next year, in a rally that Wall Street analysts didn’t predict, riskier munis outpaced the $3.6 trillion market, gaining 12.8 percent compared with the broad 9.8 percent rally.

Individuals added $8.8 billion to funds focused on junk debt in 2014 as interest rates dropped to near generational lows, Lipper US Fund Flows data show. The influx represents about 40 percent of all the cash that bond managers received last year.

Success Paths

The muni funds with top 2014 returns all focused on high-yielding debt. Eaton Vance Management’s fund gained 17.9 percent, third-best, followed by AllianceBernstein Holding LP’s, which rose 17.7 percent, and BlackRock Inc.’s, which rallied 17.6 percent, Bloomberg data show.

By comparison, the Standard & Poor’s 500 Index of stocks, a standard benchmark of capital market return, earned 13.7 percent in 2014.

High-yield fund managers have many more options than 500 stocks. They earned their returns by selecting from a universe of more than 1 million unique muni bonds.

“The beauty of the high-yield muni market is there’s no one way to success,” said Tom Metzold, co-director of munis in Boston at Eaton Vance, which oversees $22 billion in local debt.

For example, Eaton Vance’s largest holding in its national high-yield fund for the first nine months of 2014 was general obligations from California, which isn’t speculative grade. In fact, its Moody’s Investors Service rating of Aa3 is its best since 2001.

Eaton Vance also speculated in riskier Detroit water and sewer bonds. Some of the debt was bought back under a plan approved by the city’s water board at prices as high as 119.1 cents on the dollar.

Prepa Pain

AllianceBernstein’s top holding as of Oct. 31 was sewer debt from another municipality that recently exited bankruptcy: Jefferson County, Alabama. Among the BlackRock fund’s top 10 holdings are tobacco bonds and Puerto Rico obligations issued in March with an 8 percent interest rate.

The Nuveen funds don’t hold any of the Caribbean island’s securities. The Puerto Rico bonds have fallen from their initial price, as the Puerto Rico Electric Power Authority creates a plan to shore up its finances. That may include imposing losses on holders of $8.6 billion of debt.

“There’s a monetary default coming for Prepa,” Miller said, referring to the power agency.

Risk Rally

Investors looking to avoid the $73 billion of debt from Puerto Rico and its agencies have driven down yields for other riskier issuers. The spread on BBB revenue bonds has plunged to 0.85 percentage point, compared with 2.9 percentage points to begin 2013, the data show.

“In high yield, it’s likely we’ll see more muted returns than 2014, but still positive,” said Peter Hayes, head of munis at BlackRock, the world’s largest money manager.

Also helping suppress yield spreads, is the lack of new junk-bond sales, Miller said. With few new deals, Nuveen has purchased 80 percent of its debt from other holders in the secondary market, he said.

The company’s flagship high-yield fund was awash with cash to invest -- the $2.06 billion infusion represented 29 percent of the assets with which it started the year. Only Vanguard Group Inc.’s intermediate- and limited-term funds received more, according to company data through Nov. 30 compiled by Bloomberg.

Eaton Vance’s high-yield fund had $270 million flowing in, or 44 percent of its assets at the year’s start, Bloomberg data show. It ranked among the top 10 funds in inflows as a percentage of assets, as did Nuveen’s national fund.

“Munis should be in a good position, certainly for the first quarter,” Miller said. “One of the reasons for that is fund flows are staying positive.”

Fund Data

Below is a table of the top-performing open-end mutual funds with a municipals strategy and at least $500 million in assets.

================================================================
Rank  Ticker  Fund Name                     Total       Assets
                                            Return Ytd  (in mln)
================================================================
1     NCHAX   NUVEEN CA HI YLD MUNI BND-A   20.95%      $562
2     NHMAX   NUVEEN HIGH YLD MUNI BND-A    18.79%      $10,641
3     ETHYX   EATON VANCE HIGH YIELD MUN-A  17.86%      $967
4     MISHX   ALLIANCEBERNSTEIN MUNICIPAL   17.69%      $528
5     MAYHX   BLACKROCK HIGH YIELD MUNI-I   17.59%      $598
================================================================

SOURCE: Data compiled by Bloomberg, through Dec. 31

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