Muni Risk Radar
Here’s what’s on ours…these are some of the industry and muni market themes that we will be following this year:
- NEW: State and local economic impact of changes to U.S. immigration policy (added to the Radar 1/30)
- NEW: Potential for new Federally funded infrastructure projects to add to state local ongoing maintenance costs (added to the Radar 1/30)
- How will investors react when they see their year-end statement prices?
- U.S. Interest rates and impact on yield curve/portfolio positioning
- Global interest rates
- Muni market returns and returns relative to other asset classes
- Fed policy and inflation risks
- Changes in the tax code could affect investor demand
- Outflows from muni bond mutual funds and muni ETFs
- Investor shifts from mutual funds and individual bonds into ETFs
- New issue supply
- How will the promised increase in infrastructure spending affect the muni market?
- ETF product innovation and the risk of over-innovation
- Impact of implementation or delay of the DOL fiduciary rule as well as the potential impact of an increase in “fiduciary” awareness among investors in their non-retirement accounts
- Changes in secondary market liquidity
- Growth in algorithmic trading
- Arrival of “big data” tools and techniques
- No way to “measure” liquidity
- Shrinking number of muni dealers
- Will we see more discount bonds? Are investors aware of the onerous tax treatment for munis that are not subject to the de minimis rule?
- Active vs. Passive (or, as we see it in fixed income, Passive vs. Active vs. Indexed)
- Increase in political risk
- Changes in credit quality and potential reductions in margin of safety and effect on valuations / relative value
- Demographic and economic trends that may affect state and local finances, such as declining sales tax revenues; greater fuel efficiency and growing number of electric vehicles which will impact fuel tax collections; growth in automation which will eliminate jobs and displace workers
- Decline in oil prices could affect energy producing areas
- Growing awareness of the risks arising from public pension obligations
- Cybersecurity risks (and potential costs) for utilities, hospitals, universities and other large or prominent issuers
- Implications of SEC liquidity management rule for mutual funds
- Next year’s required disclosure of trade mark-ups may affect muni product selection (from individual bonds into funds, SMAs, model portfolios, etc.)
- Fill in the blank_____________________________________________
What do you think is missing from this list?
Depending on where you sit in the industry, you may have a different perspective. For example, mutual fund and separate account managers will need to be able to demonstrate and defend the value-add of active management amidst all of these challenges. (Even though we are proponents of using ETFs to access the muni market, we are of the opinion that the growth in index-based fixed income investments will actually increase the opportunities for active managers to find incremental value in the market.)
Advisors and investors will need to have well-formed opinions about the potential impact on their portfolios of any (or all) of these themes.
Keep in mind that borrowers do not have a fiduciary obligation to lenders, and that bond buyers can rely only on the contractual agreement that secures their bonds. To lend money for 10, 20 or 30 years requires some sense that the strength of that agreement will remain as stong (or stronger) in the years ahead.
If your clients (or you) are concerned about how to deal with these risks in a self-directed portfolio, you may wish to reconsider The Benefits of Professional Management.
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Updated January 30, 2017. The original version of this list was published in The Muni Catchup, January 3, 2017.
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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 and are subject to change without notice. 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.
©2017 Patrick F. Luby
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