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Munis May Not Be As Niche As You Think

Evaluating municipal bonds in isolation may be an incomplete approach. David Hammer, head of municipal bond portfolio management, explains how macroeconomic views can meaningfully contribute to the assessment of individual municipal bonds as well as the asset class as a whole.
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David Hammer, Head of Municipal Bond Portfolio Management: There’s a tendency for investors to look at the muni market as a niche market, one that can be viewed in isolation. We take a very different view here at PIMCO. We think that macro factors are important in thinking about the overall asset class, but also in selecting individual securities.

Macro factors like demographics, public policy, changes in housing prices, commodity prices, changes in federal tax policy are all very relevant to muni investors.

One example are municipal bonds that are backed by sales taxes.

Chart: An illustration shows the various macroeconomic inputs necessary to build a municipal bond including the following stages: retail outlook, sales tax and sales tax revenue bond.

Sales taxes can be collected on an area with an estate, a city, a town, sometimes a small district within a town. There’s a number of macro factors in play when we’re thinking about how much sales tax will be collected in the future. This can be US economic consumption, wage growth, employment trends. These were all critical from a top-down perspective, but it’s also important from a bottom-up view to understand the assets within these areas that are generating the economic activity on which those sales taxes are collected.

An example that’s very common in the municipal market is to find sales tax districts

Shots of a mall interior, then a woman walking through aisle of retail store and then a shopping center.

where a lot of that activity is backed by malls, big-box retail, other areas that may be under stress at this point in the cycle.

At PIMCO, we rely heavily on our corporate credit team

Shot of a PIMCO credit team meeting.

to look at these individual retailers and give us signs of economic health. We also rely on our commercial real estate team to give us an idea of what these individual assets might be worth.

Chart: An illustration shows the various macroeconomic inputs necessary to build a municipal bond including the following stages: assessing home values, property taxes and local general obligation bond.

Another example would be local general obligation bonds that are issued to fund education. Many of these bonds are backed by property taxes. Those property taxes are calculated based on the assessed value of homes, and that’s based on market-to-market valuations of houses. There are a number of macro factors that can impact housing valuations.

These include mortgage rates, shifting demographics, the potential loss of a state and local tax deduction, which has become very relevant in parts of California and New York.

We rely on our housing team to help us assess risk in these types of investments.

Shots of PIMCO employees working.

Our muni portfolio team is backed by the full power of PIMCO leveraging our time-tested investment process to identify opportunities and risk in the muni market.

We believe it’s critical to have both a robust macro process and a broad credit expertise that extends far and beyond traditional state and local government finance.

Shots of PIMCO employees working.

We believe that the combination of those things might help to deliver better outcomes for our municipal investors.

For more insights and information visit pimco.com

Disclosure

 

Recorded 23 May 2019

All investments contain risk and may lose value. Income from municipal bonds is exempt from federal income tax and may be subject to state and local taxes and at times the alternative minimum tax; a strategy concentrating in a single or limited number of states is subject to greater risk of adverse economic conditions and regulatory changes. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2019, PIMCO.

CMR2019-0617-402037

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