Text on screen: PIMCO
Text on screen: The Market
FULL PAGE GRAPHIC TITLE – After a Rough 2022, Strong 4Q23 Performance Brought 2023 Returns to Positive. The subtitle reads, Investment Grade, or IG, and High Yield, or HY, Municipal Indices Performance: 2023 versus 2022.
The slide shows two bar charts. The chart on the left is a comparison of fourth quarter 2023 and fourth quarter 2022 perfomance. It shows that High Yield Municipal bonds returned 9.21% in the fourth quarter of 2023, outperforming Investment Grade Municipal bonds, which returned 7.89% return during the same period. In the fourth quarter of 2022, Investment Grade Munis posted a 4.1% return, outperforming High Yield Munis, which rose 3.48%. The chart on the right is a comparison of 2023 and 2022 returns, showing that for the full year 2023, High Yield Munis returned 9.21%, while Investment Grade Munis rose 6.4%. For the full year 2022, High Yield Munis declined 13.1%, while Investment Grade Munis fell 8.53%.
While Q3’s negative performance for both investment grade and high yield munis pushed 2023 returns into the red, the 4th quarter was an exceptional performance year for munis across the board, bringing 2023 annual returns to positive for both segments of the market. During the quarter, a large-scale rally in rates paired with improved technicals supported an exceptionally strong positive performance for the asset class.
In fact, Investment Grade and High Yield munis finished the fourth quarter up +7.89% and up +9.21%, helping deliver full year returns of +6.40% and +9.21% for Investment Grade and High Yield munis, respectively. November marked the best single month for Investment Grade muni returns since 1982 alongside the best month for High Yield munis since 2009.
FULL PAGE GRAPHIC TITLE – Performance
Image on screen: A disclaimer on the top about performance metrics followed by a performance table in the middle for Dec 31st 2023.
MuniFlex successfully participated in the rally, delivering a very strong fourth quarter return of +9.60%. In November specifically, the fund was up 8.25%, its highest single month return since inception, again demonstrating its ability to maximize returns in a muni recovery cycle.
Though rates no longer sit at decade plus highs, they are still very attractive from a historical perspective and can provide meaningful value for tax-aware investors. For example, as of 12/31/23, the Bloomberg Muni Bond Index YTW is in a position where it's considered cheaper than 88% of the time over the past 10 years
Muni fund outflows ended 2023 at -$16.1bn, extending what is now a 2 year span of net outflows. While it’s impossible to predict the timing when we’ll see consistency of inflows again, we’d expect to see an influx of demand for munis in an environment where rate volatility continues to subside, and the Fed sticks to its current path of easing policy in 2024.
With yields remaining near their higher levels in recent history, alongside what we expect to be resilient credit conditions ahead, our muni outlook remains highly constructive.
Text on screen: MuniFlex positioning
FULL PAGE GRAPHIC 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 7.73 years. The next column shows average duration, which is 7.39 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 overall risk profile – adding exposure where we are finding attractive opportunities but doing so cautiously amid persisting volatility and ongoing economic uncertainty.
The current shape of the tax-exempt yield curve remains inverted in the 2-10portion but 100bps+ steep in the 10-30 portion. As a result, we’ve maintained a barbell approach, focusing on ultrashort floating rate exposure paired with long duration bonds that are trading at cheaper levels.
We increased duration by ~1/4 year over the quarter to take advantage of long-end opportunities which paid off during the recent sharp decline in interest rates. That said, we’re maintaining what we’d consider a neutral duration stance at ~7.7 yrs, marginally higher than the Fund’s long-term average.
The fund’s leverage, albeit more expensive today than in lower interest rate environments, continues to provide liquidity and dry powder to take advantage of higher yielding dislocated opportunities as they arise. While void of tender option bond leverage today, our current preferred share leverage remains well below the max limit of 42.5.
We maintain a favorable view on private placement muni opportunities which may provide both a liquidity and complexity premium and are a conducive liquidity match to MuniFlex’s interval fund structure.
More importantly, in terms of sector positioning, we have been increasing exposure in a few key areas: Firstly, affordable housing opportunities continue to be among our highest conviction trades today, where we continue to find attractive securities across the sector. This includes government guaranteed bonds offering tax-free yields in the 4.5-5% range, which is comparable to maturity matched BBB yields, as well as direct whole loans with yields in the 6-8% tax-free range. Looking ahead, we will continue to build out this exposure in MuniFlex, ultimately targeting a ~10-15% sector allocation.
Additionally, we are finding increasing opportunities within both the healthcare and pre-paid gas sectors. While we remain cautious on high yield Not-For-Profit healthcare, we’ve been increasingly finding opportunities in higher quality healthcare names that have strong balance sheet positions alongside more attractive cost structures. Regarding pre-paid gas bonds, they carry senior financial institution risk, an area of the market we have great expertise in as a firm, providing us with a competitive edge on the analysis front.
Finally, when thinking about credit exposures today, although IG valuations came down amid the recent rally, we still broadly favor investment grade bonds that are trading at more attractive valuations, recently near or at that of select sub-IG yield levels. That said, we continue to see select opportunities in the HY segment as well, particularly in areas that offer more resilient cash flow characteristics in the face of declining economic conditions.
Text on screen: The opportunity
FULL PAGE GRAPHIC TITLE – Municipal Supply and Demand Technical Tailwinds in Jan/Feb are Not New. The subtitle reads, Average Monthly Gross Municipal Issuance (in billions of U.S. dollars) Since 2000.
The bar chart shows that over the last 23 years, on average, the months of January and February have been the two lowest months of gross municipal bond supply – and when supply and demand technicals have tended to be at their most supportive. January is shown in red at $23.5 billion, and February is in green at $25.9 billion. The rest of the months are in blue and show $34 billion for March, $31.8 billion for April, $33.8 billion for May, $39.9 billion for June, $29.5 billion for July, $32.6 billion for August, $29.2 billion for September, $38.2 billion for October, $32.3 billion for November, and $31.8 billion for December.
Looking ahead, a backdrop of yields sitting at the upper end of their 10 year ranges is attractive, but on top of that, supply & demand technicals tend to be at their most supportive conditions at the start of calendar years.
In fact, over the last 23 years, on average, the months of January and February, are the two lowest months of gross muni supply. At the same time, demand tends to be much higher during this period, as both reinvestment capital and fresh money typically hit the market, resulting in net negative supply that provides a boost to the asset class.
Over the last 10 years, the Bloomberg Muni bond Index has returned positive performance in January in all but 2 years, with an average monthly return of 80 basis points for the month.
For January 2024, net supply is expected to total -$8bn, in line with what we typically see.
Bottom line, as we look ahead, the outlook for MuniFlex is as bright as ever, with an extremely conducive environment for the fund’s investment strategy that utilizes its structure and tactical leverage to drive alpha.
Furthermore, attractive yields, ongoing credit strength, supportive technicals, and an increasing pipeline of investment opportunities for the fund are just a few of the key reasons that MuniFlex is our highest conviction muni strategy for 2024.
Text on screen: The recap
FULL PAGE GRAPHIC TITLE – MuniFlex Recap
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 Looking ahead. The bullet under Market Review read, An impressive rally in rates drove strong Q4 performance, helping solidify impressive 2023 calendar year returns; The bullet under Portfolio Positioning read, The Fund continues to take advantage of the ripe opportunity set, maintaining a modestly extended duration profile and adding to securities within the affordable housing space; The bullet under Looking Ahead, Supply and demand technicals tend to be at their most supportive conditions at the start of calendar years, driving net negative supply
Text on screen: For more insights and information visit pimco.com
Text on screen: PIMCO
As of December 31, 2023. SOURCE: PIMCO, Bloomberg
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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). 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.
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Investment Grade (IG); High Yield (HY); US Federal Reserve (The Fed);
IG Munis proxied by the Bloomberg Muni Bond Index
HY Munis proxied by the Bloomberg HY Muni Bond Index
Yield to Worst (YTW) is the estimated lowest potential yield that can be received on a bond without the issuer actually defaulting. The YTW is calculated by making worst-case scenario assumptions by calculating the returns that would be received if provisions, including prepayment, call, or sinking fund, are used by the bond's issuer. The measure is not necessarily indicative of a portfolio’s worst possible performance.
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