Q: Are Munis Going Out of Style?
Direct ownership of individual municipal bonds went down in the second quarter, and is down for the year. Meanwhile, indirect ownership of munis through mutual funds, closed-end funds and ETFs grew. In fact, the growth in indirect ownership far exceeded the decline in direct ownership.
Municipal Securities: Household Direct and Indirect Ownership
Source: Federal Reserve, September 16, 2016. Dollar amounts in billions.
In the first half of the year, money market mutual fund holdings of munis declined by $52 billion–an amount that is not surprising given the pending changes with money market funds. (If you need a refresher on the reform, the ICI has a nice summary available here.)
While the municipal bond market is still dominated by individual investors, the relative value of munis continued to attract other buyers as well, as insurance companies added $7.4 billion in munis and banks added over $25 billion.
Even non-muni bond mutual funds were buyers of munis in the first half, adding $9.1 billion in munis. Foreign buyers added $2.2 billion to their munis holdings.
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 how liquidity for munis has declined over the last several years.
Since it peaked in 2006, broker/dealer support of the municipal bond market has declined by 61%. While there has been a recent uptick in support, as shown in the graph below, most longtime muni market participants are familiar with how much more difficult it can be to trade out-of-favor bonds. By using mutual funds or ETFs, however, investors are able to access liquidity through different and more predictable processes, perhaps explaining some of the growth in the flow into muni funds.
Munis are not going out of style. Even with the recent decrease in ownership, direct ownership of individual muni bonds clearly remains very popular. In addition, there has been a large and growing appetite for professionally managed munis in mutual funds, closed-end funds and ETFs. (See the Context page for additional information about recent muni bond mutual funds and ETFs flows.)
Income Investor Perspectives
by Pat Luby
September 16, 2016
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.
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