Income Investor Perspectives

Welcome to this special edition of Pat Luby’s Muni Catchup

Funds are Flowing into Munis: The Fed released the quarterly Flow of Funds Report on Thursday, June 9, confirming what many of us already know: that there were substantial inflows into the municipal bond market in Q1 2016:

The municipal bond market has been and remains dominated by demand from individual investors. Through direct ownership, individuals own 43% of the market. When combined with indirect ownership (through closed and open-end funds and ETFs), individual investors represent almost 2/3rds of the muni bond market.

The first quarter upward trend in muni ownership comes amidst widespread dissatisfaction with interest rates. Yet, equity market volatility, coupled with an increased awareness of goals-based investing seems to be attracting more assets into munis.

Notable increases for the quarter:

• Household direct ownership +$11.5 billion (up 1%)
• Mutual Fund ownership +$24.7 billion (up 4%)
• ETFs +$1.8 billion (up 10%)
• Property & Casualty Insurance Companies +$2.6 billion (up 1%)
• Life Insurance Companies +$3.3 billion (up 2%)
• Non-U.S. ownership +$2.0 billion (up 2%)

In the quarter, even non-muni bond mutual funds added muni bonds to their portfolios, increasing by $2.4 billion to an estimated total of $12.7 billion.

Non-U.S. investors added $2.0 billion in munis, now totalling $89.2 billion. Since even U.S. tax exempt muni yields are often higher than bond yields available in overseas markets, it is not surprising that non-U.S. participation in the muni market is growing. (Consult the Context page for an analysis of benchmark muni yields. Click here to go to the Bloomberg.com Global Bond Benchmarks page to see yields from around the world. Have your magnifying glass handy.)

Money market mutual fund holdings of munis dropped by $29.3 billion, even as total money market mutual fund assets in the quarter increased by $4.1 billion. (Holdings of U.S. Treasury securities increased by $62.6 billion.) As fund managers continue to prepare for the October deadline for implementing a floating NAV on Institutional money market funds, there may be a continued shift of holdings in some money market funds from municipals into more-liquid U.S. Treasury securities.

Muni Market Liquidity: Looking at the amount of financial assets reported by broker-dealers as a proxy for their market-making activities (and therefore the depth of markets) reveals why liquidity in some markets–especially for munis–has declined over the last several years.

This chart is not intended to imply complete precision in the amount of capital deployed by the broker-dealer community to the markets, but rather to be indicative of the trend of their level of activity in the markets.

Since the end of 2006, while overall market support was down 27%, the estimated amount of broker-dealer assets devoted to supporting the municipal bond market has declined by 63%. The reduced support of the municipal bond market is not surprising, as the trend reinforces the anecdotal observations about the changing nature of secondary market liquidity. The first quarter uptick in munis held by broker/dealers–the first increase since 2010–should be welcome news for investors and portfolio managers.

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By the way, if you have clients who are under-allocated to fixed income and who have been waiting for rates to go up, I encourage you to read (and share) my article about how to time interest rates. I also recommend my article that explains the benefits of professional management.

As always, your comments and questions are welcome and appreciated.

I’ll be back on Monday with the next regular edition of the Muni Catchup.

Thanks for reading, and best wishes for a great weekend!

Pat

The opinions expressed and the information contained herein are based on sources believed to be reliable, but accuracy or appropriateness is not guaranteed. Past performance is interesting but is not a guarantee of future results. Investments in bonds are subject to gains/losses based on the level of interest rates, market conditions and credit quality of the issuer. Indices are not available for direct investment, although in some cases, there may be ETFs available designed to track some of the indices shown. The author does not provide investment, tax, legal or accounting advice–this is NOT investment advice. Investors should consult with their own advisor and fully understand their own situation when considering changes to their strategy, tactics or individual investments. Additional information available upon request.