Text on screen: PIMCO
Text on screen: The Market
Text on screen: TITLE – Municipal fund outflows persist amid broader rate market volatility ; SUBTITLE – 2022 YTD vs. 2023 YTD Industry Fund Flows
Image on screen: A line graph shows year-to-date cumulative municipal outflows 2022 YTD versus 2023 YTD. A horizontal line representing zero outflows is situated near the top of the graph, with increasing outflows marked by a negative progression down the Y-axis. Outflows for 2022 YTD were $91.5 billion, with the line on the graph descending steadily and steeply from January to September. By contrast, during the same period for 2023, outflows were much less, totaling $12.0 billion. While the outflows are shown by a slightly declining green line in 2023, it is relatively flat compared with last year’s outflows.
While the first half of 2023 was broadly a strong period for municipal bond performance, The third quarter was a materially more challenging environment for the asset class.
Net negative supply (meaning reinvestment capital outpacing new issuance) throughout the summer months of July/August in the third quarter was a supportive technical, but rising rates paired with an acceleration of muni fund outflows, particularly in September, resulted in the BBG Muni Bond Index and High Yield Muni Bond Index, underperforming their taxable fixed income counterparts over the quarter. Although high yield muni spreads tightened roughly 20bps over the quarter, the main driver of the High Yield segment’s underperformance relative to IG was duration, as the High Yield index carries ~1yr more of duration vs IG, and tax-exempt yields rose meaningfully over the period as represented by the AAA tax-exempt muni yield curve.
The move higher in rates was a significant headwind in the third quarter, but today, yields are sitting at extremely attractive levels, with the IG Muni Index Yield To Worst hitting it’s 10+ year high, the highest level since November of 2008, during the Global Financial Crisis.
While Year To Date outflows have extended to 12 Billion, it pales in comparison to 2022 where we saw the largest muni outflow cycle on record with 122 Billion leaving the asset class. While we don’t expect any immediate reversal to inflows, we’d expect to see an influx of demand back into the market as rate volatility subsides and the Fed’s path for longer-term policy becomes clearer.
With yields remaining at their highest levels in recent history alongside what we expect to be resilient credit conditions ahead, our muni outlook remains highly constructive, keeping in mind the potential for ongoing near-term volatility.
Text on screen: MuniFlex positioning
Text on screen: TITLE – Current portfolio positioning
Image on screen: The figure shows a table listing four key MuniFlex statistics: Duration, effective leverage ratio, private placements, and high-yield exposure. The first row of the table highlights duration, listed in the first column. The second column shows current duration, at 7.49 years. The next column shows average duration, which is 7.36 since inception of the fund on 15 March 2019. On the right-hand side, a column shows horizontal plots of historical ranges. For duration, the current level of 7.49 years is just to the left of the middle of the duration’s historical range of about 6.2 to 9.3 years. Moving down to the next row, the table focuses on the effective leverage ratio, which is 23%, compared with an average of 21% since inception. A horizontal plot on the right shows the current ratio of 23% around the middle of its historical range of roughly 12% to 34%. The next row shows private placements, ranging historically between 8% and 25%, with the current level of 24%. In the final row at the bottom, high yield is highlighted. The current level is 35%, above the average since inception of 33%, near the far right of its historical range between 18% and 40%.
MuniFlex has maintained a moderate risk profile – adding exposure where we are finding attractive opportunities but doing so cautiously amid persisting volatility and ongoing economic uncertainty.
Given the current shape of the tax-exempt yield curve with the 2-10yr inversion but a steep long-end, we continue to structure the portfolio with a barbell approach, selling front-end and intermediate risk with richer valuations while pairing ultrashort floating rate exposure with long duration bonds that are trading at cheap levels.
We’ve continued to increase interest rate exposure modestly given attractive long-end opportunities albeit still what we would consider neutral at 7.5 years, in line with the Fund’s long-term average amid continued rate volatility.
From a leverage perspective, we continue to maintain liquidity and dry powder to aim to take advantage of further opportunities as they present themselves, with current leverage well below the maximum of 42.5%.
We continue to find value in private placement muni opportunities, currently running a 24% allocation relative to our 17% historical average.
In fact, one of our highest conviction sectors is affordable housing, which is predominantly accessed through private placement deals. Within affordable housing, we remain focused on Low Income Housing Tax Credit, tax-exempt bonds and loans which typically have lower LTVs and less default risk than similarly rated traditional muni credit. MuniFlex’s interval fund structure positions the fund to invest in these less liquid opportunities to seek a meaningful yield premium.
More broadly, in terms of sector positioning, we have been increasing exposure to a number of other areas.
For example, we are finding increasing opportunities within both the special tax and pre-paid gas sectors. Many of these special tax opportunities provide resiliency in cash flows with strong collateral while pre-paid gas bonds carry senior financial institution risk, and area of the market we know very well as a firm and favorite today.
Also, we’re finding attractive opportunities in the broader housing space, which more recently includes tax-exempt Freddie Mac guaranteed housing bonds with fully tax-free yields in the 4.75-5% range. We have been able to purchase some of them at spreads as wide as 50bps relative to maturity matched BBB risk, which we see as a tremendous relative value opportunity.
Lastly, we continue to find investment grade opportunities with very attractive yields, particularly 15 yrs out on the curve and are also constructive on select High Yield opportunities that may present attractive relative value with strong risk-return profiles in potential downside scenarios.
Text on screen: The Market
Text on screen: TITLE – Yields are historically attractive and provide strong forward looking potential
Image on screen: There are two charts side-by-side. The bar chart at left shows the Yield to Worst (YTW) range for 10-year Investment Grade and High Yield bonds as measured by the Bloomberg Municipal Bond Index and the Bloomberg High Yield Municipal Bond Index, respectively. The Bloomberg Municipal Bond Index reached its highest level observed since 2008; the taxable equivalent YTW (assuming the highest federal tax rate) for the index was 7.31% as of September 30, 2023. The Bloomberg High Yield Municipal Bond Index reached its highest yield since 2017. The taxable equivalent YTW of the HY Muni Index is 10.51% as of September 30th 2023. The line chart at right show the Yield to Worst and the Forward 10-Year Return for the Bloomberg Municipal Bond Index. Looking back to 1980, the starting point of the YTW is nearly perfectly correlated (0.99) to 10-year forward returns for the Bloomberg Municipal Bond Index.
As mentioned previously, yields are sitting at compelling levels today, particularly for higher quality investment grades bonds.
The IG Muni Index has reached its highest level observed since the Global Financial Crisis in 2008. The taxable equivalent Yield To Worst, assuming the highest federal tax rate, for the index was 7.31% as of September 30, 2023.
The High Yield Muni Index has reached its highest yield since 2017, surpassing previous peaks reached during the Covid-19 correction in March 2020. The taxable equivalent Yield To Worst of the High Yield Muni Index is 10.51% as of September 30th 2023. Simply put, today is among the most attractive entry points municipal investors have seen since the Global Financial Crisis.
On top of that, looking back to 1980, starting point Yield To Worst is nearly perfectly correlated to 10-year forward returns for IG munis, creating an attractive opportunity for tax-aware investors to deploy capital at current levels. In other words, periods where you have similarly seen elevated yield levels have historically been followed by periods of strong returns.
Given Muniflex’s ability to provide liquidity during times of sell-off and capitalize on dislocations, the Fund can harness this forward looking value even more, seeking to maximize yield and overall upside in a recovery to lock in attractive yields with potential capital appreciation opportunities for the future.
Bottom line: historically attractive yields, ongoing strength in fundamentals, and a ripe pipeline of opportunities ahead make MuniFlex one of our highest conviction municipal strategies today.
Text on screen: The recap
Text on screen: TITLE – The recap: Outflows bring opportunities
Image on screen: A graphic lists bullet points that follow along with the narration of the video. The bullets are divided into three sections: Market Review, Portfolio Positioning and Yield Opportunities Ahead. The bullet under Market Review reads, “Less supportive technical factors broadly hindered municipal performance in Q3, though valuations became more attractive alongside decade high yields. The bullet under Portfolio Positioning reads, “The Fund continues to take advantage of the ripe opportunity set, increasing duration on the margin and adding exposure to favorable areas such as the housing sector. The bullet under Yield Opportunities Ahead reads, “The highest yields seen in over a decade paired with the correlation of starting YTW and forward looking returns makes today a historically attractive time to deploy capital for municipal investors.”
Text on screen: For more insights and information visit pimco.com
Text on screen: PIMCO
Disclosure
As of September 30, 2023. SOURCE: PIMCO, Bloomberg
Investors should consider the investment objectives, risks, charges and expenses of the funds carefully before investing. This and other information are contained in the fund’s prospectus and summary prospectus, if available, which may be obtained by contacting your investment professional or PIMCO representative. Please read them carefully before you invest or send money.
The fund is an unlisted closed-end “interval fund.” Limited liquidity is provided to shareholders only through the fund’s quarterly offers to repurchase between 5% to 25% of its outstanding shares at net asset value (subject to applicable law and approval of the Board of Trustees, the Fund currently expects to offer to repurchase 10% of outstanding shares per quarter). There is no secondary market for the fund’s shares and none is expected to develop. Investors should consider shares of the fund to be an illiquid investment.
Past performance is not a guarantee or a reliable indicator of future results. Portfolio structure is subject to change without notice and may not be representative of current or future allocations.
Portfolio structure is subject to change without notice and may not be representative of current or future allocations.
There can be no assurance that the trends discussed will continue. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those discussed.
Investment Grade (IG); High Yield (HY); US Federal Reserve (The Fed); Remarketable Variable Rate MuniFund Term Preferred Shares (RVMTP); Loan to Value (LTV); Great Financial Crisis (GFC)
IG Munis proxied by the Bloomberg Muni Bond Index
HY Munis proxied by the Bloomberg HY Muni Bond Inde
Yield to Worst (YTW) is the estimated lowest potential yield that can be received on a bond without the issuer actually defaulting.
Loan-to-value (LTV) ratio: a measure of lending risk that financial institutions and other lenders examine before approving a loan. Calculated by dividing the amount borrowed by the appraised value of the asset. Typically, higher LTV ratios are considered higher-risk loans.
A word about risk: Investing in municipal bonds involves the risks of investing in debt securities generally and certain other risks. Investors will, at times, incur a tax liability. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. 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 the current low interest rate environment increases this risk. Current 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. An investment in municipal closed-end funds will be subject to market risk, leverage risk, and various other risks depending upon the underlying assets owned by a fund. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. The use of leverage may cause a portfolio to liquidate positions when it may not be advantageous to do so to satisfy its obligations or to meet segregation requirements. Leverage, including borrowing, may cause a portfolio to be more volatile than if the portfolio had not been leveraged
An investment in an interval fund is not suitable for all investors. Unlike typical closed-end funds an interval fund’s shares are not typically listed on a stock exchange. Although interval funds provide limited liquidity to investors by offering to repurchase a limited amount of shares on a periodic basis, investors should consider shares of the Fund to be an illiquid investment. Investments in interval funds are therefore subject to liquidity risk as an investor may not be able to sell the shares at an advantageous time or price. The Fund anticipates that no secondary market will develop for its shares. There is no guarantee that an investor will be able to tender all of their requested Fund shares in a periodic repurchase offer.
There is no guarantee that an investor will be able to tender all or any of their requested Fund shares in a periodic repurchase offer.
PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns.
PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. 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 LLC in the United States and throughout the world. ©2023, PIMCO.
PIMCO Investments LLC, distributor, 1633 Broadway, New York, NY 10019, is a company of PIMCO.
CMR2023-1011-3164682
