Income Investor Perspectives

Independent municipal bond market insights for advisors

Month: August, 2016

Muni Catchup 8/29

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  • Using mutual funds and ETFs as a barometer, money continues to flow into the muni market–the year to date total is now close to $50 billion.
  • Last week’s comments from Fed Chair Yellen and others means that Fed intentions are now less obfuscated. (Sorry, but I just can’t use the word “clear” as an adjective here.)
  • Due to pre-holiday staffing levels, the unemployment rate number that will be announced on Friday will likely lead to an exaggerated reaction from the bond market, but investors (as opposed to traders) would likely be smart to let the number settle in to see how the markets react next week when most trading desks are back to full staffing levels.
  • As I’ve mentioned before, September muni redemptions are expected to be well below those of August, and new issue volume typically picks up after Labor Day, so the muni market–which has performed well–may be poised for some weakness if new issue supply does indeed pick up.

 

Bloomberg Now Owns the Barclays Agg!

Last week, Bloomberg announced the acquisition of the Barclays Risk Analytics and Index Solutions Business.

The Barclays fixed income indices are now part of Bloomberg. This is relevant to every mutual fund, SMA, CEF or ETF manager and trustees or fiduciaries. It is even important and relevant to financial planners, as many planning and asset allocation programs use the Barclays Agg when calculating an appropriate exposure for fixed income. Having the historical index data available via the Bloomberg terminal could be really helpful.

Bloomberg also added a new web page for the current day’s data for those without a terminal.

 

Pensions & Transparency

There was an article last week on ZeroHedge.com that provided an excellent summary of some of the challenges that have to be confronted in Illinois. Similar challenges will have to be confronted elsewhere, of course.

From the perspective of a muni bond investor, it is crucial to understand what the future obligations of a bond issuer will be. In that regard, there is some good news: the Governmental Accounting Standards Board (GASB) has provided updated guidance regarding the accounting treatment of state and local government pensions (GASB 68, effective for fiscal years starting after June 15, 2014) and other post-employment benefits (GASB 75, effective for fiscal years beginning after June 15, 2017.) In both cases, GASB recommended earlier implementation if possible.

Unfortunately, the GASB Pronouncements do not address the discount rate for calculating the present value of future liabilities. An over-optimistic rate of return will result in a lower present liability–and, therefore, most likely less political fallout because it would reduce the apparent need to provide for increased funding at the present time. A lower and more realistic rate of return will result in a larger present liability–requiring an increase in funding and most likely in taxes as well. At the present time, there is some discretion in choosing the most appropriate discount rate to use for the actuarial calculations. With that discretion comes the opportunity for favoring short-term concerns at the expense of higher future costs.

These points are important to bond buyers because the margin of safety enjoyed by investors can be undermined if other financial obligations are allowed to grow to unsustainable levels.

If you want to dig deeper into the topic, here are a few more articles:

Muni NetGuide: This May Be One “Discount” That’s not So Appealing

SeekingAlpha: Beware Of Yields Too Good To Be True: Chicago Munis

Pensions & Investments: Actuarial leaders disband task force, object to paper on public plan liabilities

Puerto Rico’s pension woes are not typical, but show what can happen when a suffering economy combines with declining demographic trends and out-migration.

(Note: amazingly, all of these articles appeared in August. That suggests to me that there will be more coverage of this topic in the fall.)

What does this mean for muni investors? For self-directed investors, caveat emptor. If you are considering long-term general obligation bonds from an issuer with a lower pension funding ratio, consider what you think the trends will be over the lifetime of the bond that you are considering. Investors without the time or skills to conduct that kind of research and analysis should consider professional management. Revenue bonds with a specific and protected stream of revenue should be less exposed to the potential financial pressures of future pension funding demands, but in severe enough cases, if taxes have to be raised so much that it leads to out-migration, revenue bonds could suffer as well. At the very least, all of this points to the importance of the annual portfolio check-up to re-visit credit quality and trends.

 

Last Call

Are you ready to squeeze everything that you need to get done this year into 83 days? Yup..there are only 83 business days between August 29 and Friday, December 30.

If you have not organized your objectives and tasks for the balance of the year, time is running out because next Tuesday, when you get back from Labor Day, you’ll be off to the races.

But don’t despair! The Summer Thinking List is designed to help you identify what you need to focus on. It’s not designed to sell you anything or to help you sell a particular product…it is designed to help you help yourself. But don’t wait! You don’t have much summer left, and the List will be taken down after Labor Day. Advisors can use the investor version to jump-start your client conversations.

Go to the Summer Thinking List for Advisors or open the PDF version.
Go to the Summer Thinking List for Investors or open the PDF version.

 

THE WISDOM OF BUFFETT

His timeless wisdom transcends seasons and appeals to young and old alike, but it is is especially in summer when I find that his insights and stories really resonate with me. I have always been impressed by how well he is able to express himself, which is why–as my family knows–I simply refer to him as The Poet. This week’s quote:

Headin’ up to San Francisco
for the Labor Day weekend show,
I’ve got my hush-puppies on,
I guess I never was meant for
glitter rock and roll.
And honey I didn’t know
that I’d be missin’ you so.
Come Monday It’ll be all right,
Come Monday I’ll be holding you tight.

Come Monday, by Jimmy Buffett

Here’s a link to a less than perfect video for the song, but it includes a fun explanatory intro from Jimmy. By the way, with Labor Day coming, it’s time to shift gears, so this will be the last installment of The Wisdom of Buffett. I hope that you’ve enjoyed them! If you need more Buffett, though, take a look at my Best of Buffett playlist.

Housekeeping

  • Oops! I realized that I had some mis-directed links on my “About Life” page, so the “Links of Note” is now working correctly.
  • Look for a Special Edition of the Catchup late this week with some recaps of the market for August, with the next complete edition expected to be published on Tuesday.

 

THE BOTTOM LINE

 Pay Attention to Call Risk & Extension Risk: Will the Fed raise rates? We’ll have to wait to see, but today’s low rates could go down, and you wouldn’t want to be forced to reinvest at even lower rates, so beware of how concentrated your call risk is–especially before you add any additional callable bonds to your portfolio. Also, do you have any bonds that are currently priced to a call but that would be at risk of getting priced to maturity if rates do go higher? If that happens, it could mean that you would then be subject to much higher interest rate risk because the duration for bonds is calculated based on the “priced to” date. This is what is referred to as extension risk, and investors should be on the lookout for it if rates do in fact begin to shift higher.

Beware the Coupon: All other things being equal, lower coupons mean higher duration and therefore higher interest rate sensitivity. Add in the unfavorable tax treatment of market discount on munis and investors who do not plan on holding bonds to maturity should be wary of buying par or discount bonds.

Don’t Forget Taxable Munis! Investors who do not need the tax exempt feature of munis should compare the yields on taxable muni bond offerings versus comparably rated corporate bonds. They can be hard to find, so if this makes sense for your situation, also consider a mutual fund of ETF.

Curve Positioning: Don’t pick a spot on the curve because of the yield, pick it because it adds the right risks to your portfolio. Pay attention to the duration (not just the maturity) whether you are looking at a bond, a fund or an ETF. The Context page provides some helpful numbers on the muni curve.

Credit Positioning: If the economy improves, rates would be expected to move higher and credit spreads would be expected to tighten. At the right price, taking on some credit risk might be ok, but it makes sense to favor the more liquid parts of the muni market, which generally means single-A rated or better. If you are tempted by the yields and returns in non-investment grade munis, exposure should be for only a minor portion of the fixed income allocation and should be professionally managed and broadly diversified.

Catchup Bottle 1132 by 468This is not investment advice. 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. 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.
©2016 Patrick F. Luby
All Rights Reserved

Mini Muni Catchup 8/24

Just a short note…two important stories from today that I will comment on in next week’s Catchup:

Bloomberg Completes Acquisition of Barclays Risk Analytics and Index Solutions Business

Barclays fixed income indices are now part of Bloomberg. This is relevant to every mutual fund, SMA, CEF or ETF manager and trustees or fiduciaries. Having the historical index data available via the Bloomberg terminal could be really helpful.

Illinois Warns Of “Crippling Tax Hikes”, “Devastating Impact” If Largest Pension Fund Admits Reality

This article on Zero Hedge provides a great summary of some of the challenges that have to be confronted in Illinois–and, elsewhere too, of course. I’ll have more to add to this story too.

Have a great Friday and a good weekend. Watch for the regular Catchup next week!

Pat

Catchup Bottle 1132 by 468

This is not investment advice. 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. 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.
©2016 Patrick F. Luby
All Rights Reserved

Muni Catchup 8/22

The Caution Flag is Up!

IMG_5760At the beach last week, the waves weren’t intimidating, but a stiff wind was pushing a very strong current, so the lifeguards had the yellow flag up–meaning it was ok to go in the water, but with caution. Some swimmers stayed on the beach while I was out riding waves–but even as an experienced and strong swimmer, I made sure that I was within the bounds of lifeguards’ markers.

Nobody puts up flags in the bond market, but maybe they should. Rates have been bouncing around, though not with as much volatility as we have seen in recent months. The greater concern comes from the “weather.” Is the Fed going to be a headwind or a tailwind? How about GDP, inflation and the Presidential election? The winds around all of these have been shifting back and forth.

This doesn’t mean that you have to be out of the market, but it does mean that you need to be cautious.

Demand is Strong

With the shifting winds, it seems that almost every day someone is announcing their dislike of bonds as an investment class. Yet, investors continue to move assets into the muni bond market. Year to date, over $47 billion in net new money has flowed into muni bond mutual funds and ETFs. (See the Context page for details.)

What’s going on? Why are so many investors putting money into the bond market?

Income. Income is one of the best antidotes for volatility and uncertainty. Versus most taxable bonds and global bonds, municipal bonds remain attractive on a relative basis. (See the Bloomberg rates page for a current overview of global rates.) And, do you think that Federal income tax rates are more like to go up rather than down after the election? If so, that is another argument in favor of munis.

GIven the current economic and political environment, boring and predictable muni bonds are likely to continue to attract attention from investors. As we move into fall, the pace of redemptions will moderate–removing some of the demand component, and new issue volume has historically picked up after Labor Day, so yield-starved investors may see some opportunities in the months ahead. Don’t be surprised if inflows continue.

89 Days

There are 89 business days between August 22 and Friday, December 30. Are you ready to squeeze everything that you need to get done this year into those 89 days?

And let’s face it…the run-up to the election is going to subtract even more days out of your productive time. If you have not organized your objectives and tasks for the balance of the year, time is running out. But don’t despair! The Summer Thinking List is designed to help you identify what you need to focus on. It’s not designed to sell you anything or to help you sell a particular product…it is designed to help you help yourself. But don’t wait! You don’t have much summer left, and the List will be taken down after Labor Day. Advisors can use the investor version to jump-start your client conversations.

The Wisdom of Buffett

By most reports, it has been pretty quiet in the muni market…and, with two more complete weeks until Labor Day weekend signals the unofficial end of summer, trading activity is not likely to pick up much. But as soon as Labor Day is over, it will be off to the races. To help you get ready for the fall sprint, here is this week’s quote from The Poet:

First time I ran
Was to the end of the block
I didn’t know then
That it never would stop
Now I look around
And what do I see
More and more people
Running faster then me
These days
Everybody’s on the run

Everybody’s on the Run, by Jimmy Buffett, from Last Mango in Paris.

THE BOTTOM LINE

Don’t try to time the market! You cannot time the market. If you have money to put to work, be prepared to put it to work. What does your investment policy statement call for? (What? You don’t have an IPS? You need to have an IPS to reduce the influence of emotion on your decisions to buy, sell or hold. Contact me if you need resources to write an IPS.) If you can’t find exactly what you want or need, using a muni ETF can be a good placeholder to maintain your asset allocation until you find the right bonds. See my Bibliography for links to articles about mixing ETFs into your bond portfolio, and for my guide to selecting muni ETFs.

Check Your Call Risk: Rates could go down, and getting bonds called away to reinvest at future lower rates can add lifestyle risk to those living off of their interest income. If you hold premium bonds (and who doesn’t?), beware of how concentrated your call risk is–especially before you add any additional callable bonds to your portfolio.

Beware the Coupon: All other things being equal, lower coupons mean higher duration and therefore higher interest rate sensitivity. Add in the unfavorable tax treatment of market discount on munis and investors who do not plan on holding bonds to maturity should be wary of buying par or discount bonds.

Don’t Forget Taxable Munis! Investors who do not need the tax exempt feature of munis should compare the yields on taxable muni bond offerings versus comparably rated corporate bonds.

Curve Positioning: Don’t pick a spot on the curve because of the yield, pick it because it adds the right risks to your portfolio. Pay attention to the duration (not just the maturity) whether you are looking at a bond, a fund or an ETF. Read this article if you need a refresher on Duration.

Credit Positioning: If the economy improves, rates would be expected to move higher and credit spreads would be expected to tighten. At the right price, taking on some credit risk might be ok, but it makes sense to favor the more liquid parts of the muni market, which generally means single-A rated or better. If you are tempted by the yields and returns in non-investment grade munis, exposure should be for only a minor portion of the fixed income allocation and should be professionally managed and broadly diversified.

What Are Your Concerns?

If you ever have a question or a concern about the muni market and feel that it would be helpful for me to get involved, please do not hesitate to use me as a resource.

Have a great week, and thanks for reading,

Pat

Screen Shot 2016-07-11 at 8.44.33 AMThis is not investment advice. 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. 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.
©2016 Patrick F. Luby
All Rights Reserved

Muni Catchup 8/15

Screen Shot 2016-07-11 at 8.44.33 AMThis Week in the Muni Catchup

  • 3 Fewer Muni ETFs
  • Speaking of Muni ETFs…
  • Caveat Emptor
  • The Wisdom of Buffett
  • The Bottom Line

 

3 Fewer Muni ETFs

State Street Global Advisors announced that 12 ETFs will be closing soon, and that among them are 3 muni bond ETFs that are sub-advised by Nuveen. (BABS, CXA and INY.) While the three that are closing are the smallest of the SPDR muni ETFs, it does seem surprising given the $45+ billion in inflows into the municipal fund market this year, that these three funds have not been able to attract more attention from investors. In particular, BABS, which is focused on taxable Build America Bonds, a part of the muni market which I have viewed as presenting an overlooked opportunity for investors seeking taxable income. (There is a weekly update of flows into muni open-end mutual funds and ETFs on the Context page.)

Speaking of Muni ETFs…

For the first time in several years, munis will be on the agenda for this year’s Inside ETFs  Inside Fixed Income Conference. There is a great line-up of speakers and ideas, so please consider joining me in Newport Beach in November. I will be presenting “The Case for Muni Bonds: Active vs. Passive in the Puerto Rico Era.”

Click here to see the complete agenda and to register.

Click here to read more of my articles about muni ETFs.

Caveat Emptor or Audentes Fortuna Iuvat?

Bloomberg reports the approval of a plan to issue $800 million in munis to finish construction of what Governor Christie called “the ugliest damn building in New Jersey, and maybe America.”

The bonds will be non-rated and when they come to market will no doubt offer investors a much higher yield than investment grade bonds.

“Buyer Beware”? Some investors may reject the bonds offhand simply because of the garish appearance of the buildings (see for yourself) or a general distrust of non-rated bonds.

Or, does “Fortune Favor the Brave”Other investors may be inclined to overlook some of the risks in order to pursue the promise of the higher yields.

Neither reaction is an appropriate way for the prudent investor to decide whether or not to buy. As Ben Graham wrote in The Intelligent Investor, “Operations for profit should be based not on optimism but on arithmetic.” (From Chapter 20, Margin of Safety.)

Self-directed investors who may be tempted to consider bonds such as these need to be honest with themselves about their ability to judge the merits and risks involved, and–even more importantly–their ability to maintain surveillance on the issuer’s ongoing financial condition. With rare exception, my preference would be that for investors for whom high yield is appropriate, consider using a professional manager to do so by investing with a high-yield open end mutual fund or one of the high-yield ETFs. Even for investors with a portfolio of individual bonds, adding a fund or an ETF to the portfolio is worth considering. (For additional reading, I recommend reading my article about The Benefits of Professional Management and my two articles published by Van Eck about adding ETFs to a portfolio of munis. See the links on my Bibliography page.)

So after the bonds are issued for American Dream, fund and ETF owners may see them show up in their underlying portfolios, but they will be there because the portfolio manager made a rational decision based on arithmetic–not an emotional decision based on a need for income or an aversion to an ugly building.

Buyer beware? Yes–always. And does fortune favor the brave? Perhaps, but in my experience, fortune more often favors the prepared.

NOTE: The Intelligent Investor is on my all-season list of recommended books.

IMG_5780The Wisdom of Buffett

Is it hot where you are? It’s hot here..it has been hot, and the forecast is for more hot. In fact, right now it is hotter where I live than this well-known destination. Even though they have wide easy roads that have been recently repaved, I do not want to go there.

A better course of action may be to slow down and chill out with some “Wisdom from Buffett.” It is especially in summer when I find that his insights and stories really resonate with me, but his timeless wisdom transcends seasons and appeals to young and old alike. I have always been impressed by how well he is able to express himself, which is why–as my family knows–I simply refer to him as The Poet. This week’s quote:

The more we learn the less we know
What you keep is what you can’t let go
Take it fast or take it slow
Just one way for you to go
Don’t chu-know

From Don’t Chu Know, by Jimmy Buffett

THE BOTTOM LINE

Check Your Calls: Didn’t believe that rates could go down again, did you? Declining rates can mean an increase in market value but also an unwelcome increase in call risk. If you hold premium bonds (and who doesn’t!), beware of how concentrated your call risk is–especially before you add any additional callable bonds to your portfolio.

Beware the Coupon: All other things being equal, lower coupons mean higher duration and therefore higher interest rate sensitivity. Add in the unfavorable tax treatment of market discount on munis and investors who do not plan on holding bonds to maturity should be wary of buying par or discount bonds.

Don’t Forget Taxable Munis! I’ve written this before, and I’ll write it again: Don’t Forget Taxable Munis! Notwithstanding the pending closure of BABS, investors who do not need the tax exempt feature of munis should compare the yields on taxable muni bond offerings versus comparably rated corporate bonds.

Curve Positioning: picking a spot on the curve is too much like trying to time rates–of which I am not a fan. Going out to the “bump” in the muni curve around 20-years can be tempting as there is not much incremental yield to incent investors to go further, and because of the slope of the curve, holding today’s 20-years bonds as they approach maturity may offer some nice price appreciation–if rates remain steady. But as shown on the Context page, 20-year par bonds can have a duration of close to 15–meaning that a 1% instantaneous increase in rates would mean a 15% decline in market value. That would hurt. So when you are looking at the curve positioning, check the duration. If you are considering funds, it can also be helpful to also check the correlation with your equity holdings. (See my recent article on ETF.com for additional insights on the topic.) Additions to your portfolio should reflect first and foremost what you need to get done with the money, not how you “feel” about the market.

If you are an advisor, please contact me if you need help deciphering any of this for yourself or your clients.

Have a great week, and thanks for reading,

Pat

 

IMG_5515This is not investment advice. 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. 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.
©2016 Patrick F. Luby
All Rights Reserved

Muni Catchup 8/4

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My latest article on muni ETFs was published today on ETF.com.

Municipal bond yields may be low, but the total returns for most municipal bond ETFs have been very strong—higher than some equity returns. In addition, over the last six months, almost all muni ETFs have been negatively correlated to SPY; yet some muni ETFs have been better diversifiers than others.

Read the article for details. You can also visit my author page while you’re there if you want to read my earlier articles on muni ETFs.

 

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