David Hammer, Head of Municipal Bond Portfolio Management: We’re more than ten years since the last recession. We see munis for investors as a late-cycle haven, and as we contemplate all of our portfolio construction, individual investments through that late-cycle lens, munis screen as attractive, for a few reasons:
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The first one is low correlations to other risky asset classes, in particular equities. If you compare investment-grade munis or high-yield munis for that matter to the S&P 500 over the last decade, correlations are negative in both cases.
The second reason is a potential change in future tax policy.
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As investors look towards the next US presidential election, there’s increasing concern that the next tax rate change might be higher instead of lower, which would increase the value of tax-exempt municipals.
Shots of U.S. Federal Reserve Building.
The third reason is out-performance when rates are rising. If it turns out the fed is not done and they continue to raise rates, munis historically outperform some other fixed-income credit asset classes when rates are rising.
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And then the last reason is favorable supply and demand dynamics. Over the last decade, there have been about $11 trillion in newly created fixed-income assets.
Chart: A three-line graph shows the debt outstanding from 2008 to 2019 for Treasuries (increasing), corporates (slightly increasing) and municipal bonds (steady).
The bulk of those have been in treasuries and investment grade corporate bonds.
The muni market is actually the exact same size. Supply has not grown over the last decade.
So, supply is stable, and we set that against demand that we expect to increase over the next several years due to two reasons. One is aging demographics here in the US. As we see Baby Boomers retire and convert riskier equity portfolios to high-quality, income-producing assets, we believe munis are a perfect fit. And the other is potential tax policy. Investors are now focused towards the next presidential election and the risk that maybe tax rates might go higher than they have been in the past.
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Recorded 23 May 2019
Correlations are derived from the prior ten years of monthly returns ending 31 December 2018. “Investment-grade munis” and “high-yield munis” are based on the Bloomberg Barclays Municipal Bond Index and Bloomberg Barclays High Yield Municipal Bond Index, respectively.
Past performance is not a guarantee or a reliable indicator of future results.
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.
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