Redemption may well beget redemption, for the municipal bond market at least.
June marked the beginning of the traditional redemption season for investors in municipal bonds, and this could be a particularly strong one as those reinvesting the proceeds from redemptions and coupon payments will meet an expected drop in supply.
According to JPMorgan forecasts, there will be $142 billion of muni reinvestment flows between June and August this year and only $94 billion of new issuance, creating a shortfall of $48 billion. That compares with a gap of only $16 billion for the same period in 2016. The mismatch should see the market bid higher.
Such a positive outcome would also offer a form of redemption after a difficult period for the muni market. Early May saw Puerto Rico file for bankruptcy, while later in the month all three major credit agencies downgraded Connecticut’s rating as the state faced slumping revenues and a widening budget gap.
Then on June 1 Illinois’s credit rating was cut to a notch above junk by both Moody’s Investors Service and S&P Global Ratings, with the latter agency warning that Illinois was likely to lose its investment-grade status – unprecedented for a state – in July unless it could resolve its budget negotiations.
To focus on the problematic pockets of the municipal world, though, would ignore the wider appeal of the market and the managers who have added alpha regardless of seasonal redemption effects.
Over the past three years, the Citywire AAA-rated duo of Matthew Dalton and Brian Steeves from boutique Belle Haven Investments have delivered the highest risk-adjusted returns on the subadvised Transamerica Intermediate Muni fund.
Dalton and Steeves seek to exploit inefficiencies in the municipal bond market, investing opportunistically across the credit and maturity spectrum. Their largest exposure at the state-issuer level is Illinois, but two-thirds of their portfolio is in AAA and AA credit debt.
Second place over the past three years goes to Eaton Vance’s AA-rated Christopher Harshman and the A-rated pair of James Evans and Brian Barney. They benefited during the first quarter of 2017 from an allocation of around 20% to A credit bonds, which has since been brought down to just over 16%.
Although total returns from the BlackRock Strategic Municipal Opportunities fund – run by AA-rated Theodore Jaeckel and the + rated team of Peter Hayes, Michael Kalinoski, and James Pruskowski – have been only slightly lower than from the Transamerica and Eaton Vance strategies over the past three years, there is a significant gap in information ratio between it and the other two, suggesting its performance has been more volatile.
This is likely to be a factor of their higher exposure to high-yield bonds: 25% of their portfolio is in non-investment-grade debt with a further 18% in BBB credits, far more than either the Transamerica or Eaton Vance funds.
The Russell Investments Tax Exempt Bond fund is now managed by Albert Jalso and Gerard Fitzpatrick following the departure of AA-rated Kevin Lo from Russell in May, although it still splits its portfolio evenly between sub-advisors AB and MacKay Shields, the former drawing more on a quantitative process while the latter takes more aggressive relative-value positions.