Download Muni Bonds: Off to a Good Start in 2017

MARKETVIEW
MuniBonds:OfftoaGoodStartin2017
January30,2017
2317Views
Followingachallengingfourthquarterin2016,muniperformanceandmutual
fundflowshavebeenimproving.
Inmid-December2016,MarketViewf ocusedontheslumpinthemunicipalbondmarketinthef inal
monthsof theyear.Atthattime,acombinationof headwinds—concernsaboutthepotentialf or
higherinterestratesandchangestotaxpolicyunderthenewadministration—hadledto
substantialoutf lowsf romtax-f reemutualf undsandputpressureonmunicipalbondprices,
resultinginlossesf ormunicipalbondsinthef ourthquarter.Whathashappenedsince?
Municipalbondf undscontinuedtoseeadditionaloutf lowsinthef inalweeksof theyear.According
toMorningstar,tax-f reebondf undsexperienced$17.5billionof outf lowsinthemonthof
Decemberalone,f oratotalof $28billionoverthetwo-monthperiodf ollowingtheelection.
However,thepaceof outf lowslikelywasaf f ectedbyseasonalf actors,suchasyear-endtax-loss
trading.“Withbondpricesdroppingandstockpricesrisingaf tertheelectioninNovember,many
thoughtthatitwasbenef icialtorecognizebondlossesinordertoof f setcapitalgainsonstocks,”
saidDanielSolender,LordAbbettpartneranddirectorof municipalbondstrategies.“Withmutual
f unds,investorsneededtoselltheirsharestoachievethisobjective,”Solendercontinued,
“althoughmanyof thesaleswereactuallyexchangestootherf undsratherthanoutright
redemptionsbecauseinvestorswantedtoremaininthemarket.”
Asweturnedthepagetoanewyear,thef lowsituationhasstabilized,andhasbeenpositiveover
thepastthreeweeks.(AccordingtoLipper,weeklyreportingf undshadnetinf lowsof $974million,
$512million,and$7million,respectively,ineachof thepastthreeweeks.)
Whataboutperf ormance?Despitetheheadwindsof largemutualf undoutf lows,municipals(as
measuredbytheBloombergBarclaysMunicipalBondIndex)postedpositivereturnsinDecember,
generatingareturnof 1.2%,wellaheadof the0.1%returnof thebroadtaxablebondmarket(as
representedbytheBloombergBarclaysAggregateBondIndex).Thistrendhascontinuedinthe
f irstf ewweeksof 2017,withmunicipalsinpositiveterritory,whiletaxablebondsaremodestly
negative.AsillustratedinTable1,thebroadmunicipalmarkethasgeneratedareturnof 2.0%
sinceDecember1,ledhigherbylonger-maturityandlower-ratedmunicipals—thoseareasthat
suf f eredthemostinthef ourth-quarterpullback.
Table1:MunicipalBondPerformanceBegan2017onaPositiveNote
Returnsyeartodate(January25,2017)
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Source:BloombergandThomsonReutersMunicipalMarketData.Broadtaxablef ixedincomerepresentedbythe
BloombergBarclaysU.S.AggregateBondIndex.Municipalbondsrepresentedbymaturity-specif icsubsetsof the
BloombergBarclaysMunicipalBondIndex.High-yieldmunicipalbondsarerepresentedbytheBloombergBarclaysHigh
YieldMunicipalBondIndex.
Pastperformanceisnoguaranteeoffutureresults.Forillustrativepurposesonlyanddoesnotrepresentthe
perf ormanceof anyspecif icportf oliomanagedbyLordAbbettoranyparticularinvestment.Lower-ratedbondsmay
carrygreaterrisksthanhigher-ratedbonds.Incomef rommunicipalbondsmaybesubjecttothealternativeminimum
tax.Federal,state,andlocaltaxesmayapply.Indexesareunmanaged,donotref lectthedeductionof f eesand
expenses,andarenotavailablef ordirectinvestment.
Whataboutgoingf orward?Weposeaf ewquestionsandanswers:
Whatwillhappenwithinterestrates?Aswehavehighlightedmanytimes,accurately
predictingthedirectionof interestrateshistoricallyhasbeenverydif f iculttodo.Manyhave
anticipatedhigherratesf ormostof thepasteightyears,onlytobedisappointedthusf ar.Yes,it
wouldseemreasonablethatratesmaybeheadinghigherf romhere(sincethehikeonDecember
14),butthepaceandmagnitudeof thatmoveisveryuncertain.Andyieldshavealreadymoved
higher,withthe10-yearU.S.Treasurybondyieldrisingbynearly120basispoints(bps)sinceJuly.
Whatwillhappentothefederaltaxcode?Investorsareconcernedthatchangestothetax
codemayreducethetaxable-equivalentyieldonmunicipalbonds,and,consequently,maketaxf reebondslessappealing.Changesintaxbracketsandstatementsaboutalteringthetax-exempt
statusof municipalsaretopicsthathavesurroundedthemunimarketf ordecades.Butaswe
pointedoutinDecember,historyshowsthatthishasnothadanimpactonthemarket.According
totheCitiResearchreportwecited,thetopmarginaltaxratesf ormunicipalbondsf luctuatedin
therangeof 28–70%between1980andDecember2016.Butthereportf oundnocorrelation
betweenmunicipalyieldsandthetopmarginaltaxrate.Thisislikelybecausetheaveragetaxrate
f ormunicipalbondholdershasremainedsteady,ataround25%,duringtheperiod
surveyed.[Resultsmayhavedifferedduringdifferentintervalsinthesurveyperiod.]
Whataboutmutualfundflows?AswealsopointedoutinDecember,thisisnotthef irsttime
wehaveseenlargeoutf lowsf romtax-f reemutualf unds.Thesupply/demandimbalancemayhave
anegativeimpactonshort-termperf ormance,aswejustwitnessed.Butif weweretolookover
longertimeperiods,thef undamentalstypicallywinoutovertechnicalf actors.Further,if wewere
tolookbackoverthepastsevenyears—aperiodthatcoincidedwithmultipleperiodsof largef und
outf lows—therepresentativeBloombergBarclaysMunicipalBondIndexoutperf ormedthetaxable
BloombergBarclaysAggregateIndex,andthatperf ormanceincludedthesharppullback
municipalsexperiencedinthef ourthquarterof 2016.Thesereturns,however,donottakeinto
accountthetax-exemptincomethatmunicipalshaveprovided,andsoactuallyunderstatethe
outperf ormancethatmunicipalshavedelivered.Thevolatilityinmutualf undf lowsseemsto
suggestthatsomeinvestorstakeatacticalapproachtoallocatingtomunicipals,butthe
perf ormancerecordshowstheywouldhavebeenmuchbetterof f maintaininganallocationthrough
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thecycle.
Table2:Historically,MaintainingaMuniBondAllocationLongerTermHasBeen
Beneficial
ReturnsasofDecember31,2016
Source:BloombergandThomsonReutersMunicipalMarketData.Broadtaxablef ixedincomerepresentedbythe
BloombergBarclaysU.S.AggregateBondIndex.Municipalbondsrepresentedbymaturity-specif icsubsetsof the
BloombergBarclaysMunicipalBondIndex.High-yieldmunicipalbondsarerepresentedbytheBloombergBarclaysHigh
YieldMunicipalBondIndex.
Pastperformanceisnoguaranteeoffutureresults.Forillustrativepurposesonlyanddoesnotrepresentthe
perf ormanceof anyspecif icportf oliomanagedbyLordAbbettoranyparticularinvestment.Lower-ratedbondsmay
carrygreaterrisksthanhigher-ratedbonds.Incomef rommunicipalbondsmaybesubjecttothealternativeminimum
tax.Federal,state,andlocaltaxesmayapply.Indexesareunmanaged,donotref lectthedeductionof f eesand
expenses,andarenotavailablef ordirectinvestment.
Thereismuchuncertaintyaboutseveralf actorsthatmayaf f ectthemarket.Butaf ewthingsare
veryclear:
Relativevalueismoreattractive.Theratioof‘AAA’ratedmunicipalbondsto
comparablematurityU.S.Treasurybondsisthemostcommonmeasureofrelativevalue
fortax-freebonds.AccordingtoMunicipalMarketData,themuni/Treasuryratiofor10yearand30-yearmunicipalbondshasrisen,toapproximately95%and100%,respectively,
ascomparedtoapproximately85%ofTreasuriesinAugust2016.
Investment-gradecreditspreadsarewider.Theadditionalyieldprovidedinsingle‘A’
and‘BBB’ratedmunicipalsover‘AAA’ratedbondshasrisen.Forexample,accordingto
theBloombergBarclaysMunicipalIndex,‘BBB’ratedbondsnowofferayieldadvantageof
165bpsover‘AAA’ratedbonds,40bpshigherthanthelevelsseeninAugust.
Yieldshaveadjustedhigher—fornow.ThecombinationofhigherU.S.Treasuryyields,
moreattractiverelativevalue,andwidercreditspreadshasresultedinhighertax-free
yields,especiallyamongsingle‘A’and‘BBB’ratedbonds.Chart1illustratesthismovein
10-yearmaturitybonds,whichnowofferyieldsthatare100–160bpshigherthanwhatwas
availableinAugust.
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Chart1.MunicipalYieldsHaveAdjustedHigherSinceAugust2016
10-yearyields(asofJanuary25,2017)
Source:BloombergandThomsonReutersMunicipalMarketData.Duetomarketvolatility,themarketmaynotperf orm
inasimilarmannerinthef uture.
Pastperformanceisnoguaranteeoffutureresults.Forillustrativepurposesonlyanddoesnotrepresentthe
perf ormanceof anyspecif icportf oliomanagedbyLordAbbettoranyparticularinvestment.Lower-ratedbondsmay
carrygreaterrisksthanhigher-ratedbonds.Incomef rommunicipalbondsmaybesubjecttothealternativeminimum
tax.Federal,state,andlocaltaxesmayapply.Indexesareunmanaged,donotref lectthedeductionof f eesand
expenses,andarenotavailablef ordirectinvestment.
Overthelongterm,municipalshaveprovidedattractiverisk-adjustedreturns
versusU.S.Treasuries.Overthepast20years,10-yearmunibonds(asrepresentedby
theBloombergBarclaysMunicipalBond10-YearIndex)hasgeneratedsimilartotalreturns
to10-yearTreasurybonds(asrepresentedbytheCitigroup10-YearTreasuryBondIndex),
buthasdonesowithabout40%lowervolatility.(SeeChart2.)Thatwouldhavetranslated
tohigherrisk-adjustedreturns,evenina0%taxbracket.
Chart2:Historically,MunisHaveProvidedVeryAttractiveRisk-RewardOvertheLong
Term
Trailing20years:January1,1997–December31,2016
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Source:MorningstarDirect.
Pastperformanceisnoguaranteeoffutureresults.Forillustrativepurposesonlyanddoesnotrepresentany
specif icportf oliomanagedbyLordAbbettoranyparticularinvestment.Incomef rommunicipalbondsmaybesubject
tothealternativeminimumtax.Federal,state,andlocaltaxesmayapply.Indexesareunmanaged,donotref lectthe
deductionof f eesorexpenses,andarenotavailablef ordirectinvestment.
Themarketisf ullof uncertainty,butgiventhelong-termreturnprof ile,thehigheryields,andmore
attractiverelativevalueavailableinthemarkettoday,investorsmaywanttotakeanotherlookat
allocatingtotax-f reebonds.
Thereisnoguaranteethatmarketswillperf orminasimilarmannerundersimilarconditionsinthef uture.
ANoteaboutRisk:Thevalueof aninvestmentinf ixed-incomesecuritieswillchangeasinterestratesf luctuateand
inresponsetomarketmovements.Asinterestratesf all,thepricesof debtsecuritiestendtorise.Asratesrise,prices
tendtof all.Investinginthebondmarketissubjecttorisks,includingmarket,interestrate,issuer,credit,inf lationrisk,
andliquidityrisk.Themunicipalbondmarketmaybeimpactedbyunf avorablelegislativeorpoliticaldevelopmentsand
adversechangesinthef inancialconditionsof stateandmunicipalissuersorthef ederalgovernmentincaseit
providesf inancialsupporttothemunicipality.Incomef romthemunicipalbondsheldcouldbedeclaredtaxablebecause
of changesintaxlaws.Certainsectorsof themunicipalbondmarkethavespecialrisksthatcanaf f ectthemmore
signif icantlythanthemarketasawhole.Becausemanymunicipalinstrumentsareissuedtof inancesimilarprojects,
conditionsintheseindustriescansignif icantlyaf f ectaninvestment.Incomef rommunicipalbondsmaybesubjectto
thealternativeminimumtax.Federal,stateandlocaltaxesmayapply.InvestmentsinPuertoRicoandotherU.S.
territories,commonwealths,andpossessionsmaybeaf f ectedbylocal,state,andregionalf actors.Thesemay
include,f orexample,economicorpoliticaldevelopments,erosionof thetaxbase,andthepossibilityof credit
problems.
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ThisMarketViewmaycontainassumptionsthatare“f orward-lookingstatements,”whicharebasedoncertain
assumptionsof f utureevents.Actualeventsaredif f iculttopredictandmaydif f erf romthoseassumed.Therecanbe
noassurancethatf orward-lookingstatementswillmaterializeorthatactualreturnsorresultswillnotbematerially
dif f erentf romthosedescribedhere.
Thismaterialisprovidedf orgeneralandeducationalpurposesonly.Theexamplesprovidedarehypothetical,aref or
illustrativepurposesonly,andarenotindicativeof anyparticularinvestorsituation.
Abasispointisoneone-hundredthof apercentagepoint.
Spreadisthedif f erenceinyieldbetweentwodif f erentinvestments.
Usedasameasureof volatility,standarddeviationisaquantitycalculatedtoindicatetheextentof deviationf ora
groupasawhole.
Standarddeviationisameasureof thedispersionof asetof dataf romitsmean.If thedatapointsaref urtherf rom
themean,thereishigherdeviationwithinthedataset.Yieldistheannualinterestreceivedf romabondandis
typicallyexpressedasapercentageof thebond'smarketprice.Tax-equivalentyieldisthepretaxyieldthatataxable
bondneedstopossessf oritsyieldtobeequaltothatof atax-f reemunicipalbond.Thiscalculationcanbeusedto
f airlycomparetheyieldof atax-f reebondtothatof ataxablebondinordertoseewhichbondhasahigherapplicable
yield.
TheBloombergBarclaysMunicipalBondIndexisarules-based,market-value-weightedindexengineeredf orthe
long-termtax-exemptbondmarket.Theindexisabroadmeasureof themunicipalbondmarketwithmaturitiesof at
leastoneyear.Tobeincludedintheindex,bondsmustberatedinvestment-grade(Baa3/BBB-orhigher)byatleast
twoof thef ollowingratingsagencies:Moody's,Standard&Poor's,Fitch.If onlytwoof thethreeagenciesratethe
security,thelowerratingisusedtodetermineindexeligibility.If onlyoneof thethreeagenciesratesasecurity,the
ratingmustbeinvestment-grade.Bondsmusthaveanoutstandingparvalueof atleast$7millionandbeissuedas
partof atransactionof atleast$75million.Thebondsmustbef ixedrate,haveadated-dateaf terDecember31,
1990,andmustbeatleastoneyearf romtheirmaturitydate.TheBloombergBarclaysMunicipalBond10-Year
Indexisamaturity-specif iccomponentof theMunicipalBondindex.
TheBloombergBarclaysU.S.AggregateBondIndexrepresentssecuritiesthatareSEC-registered,taxable,and
dollardenominated.TheindexcoverstheU.S.investmentgradef ixedratebondmarket,withindexcomponentsf or
governmentandcorporatesecurities,mortgagepass-throughsecurities,andasset-backedsecurities.Totalreturn
comprisespriceappreciation/depreciationandincomeasapercentageof theoriginalinvestment.
TheBloombergBarclaysHighYieldMunicipalBondIndexisanunmanagedindexconsistingof noninvestmentgrade,unratedorbelowBa1bonds.
TheCitigroup10YearTreasuryBondIndexisabroadmeasureof theperf ormanceof themedium-termU.S.
Treasurysecurities.
Indexesareunmanaged,donotref lectthedeductionof f eesorexpenses,andarenotavailablef ordirectinvestment.
Thecreditqualityof thesecuritiesinaportf olioisassignedbyanationallyrecognizedstatisticalratingorganization
(NRSRO),suchasStandard&Poor’s,Moody’s,orFitch,asanindicationof anissuer’screditworthiness.Ratings
rangef rom‘AAA’(highest)to‘D’(lowest).Bondsrated‘BBB’oraboveareconsideredinvestmentgrade.Creditratings
‘BB’andbelowarelower-ratedsecurities(junkbonds).High-yielding,non-investment-gradebonds(junkbonds)involve
higherrisksthaninvestmentgradebonds.Adverseconditionsmayaf f ecttheissuer’sabilitytopayinterestand
principalonthesesecurities.
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TheopinionsinMarketViewareasof thedateof publication,aresubjecttochangebasedonsubsequent
developments,andmaynotref lecttheviewsof thef irmasawhole.Thematerialisnotintendedtoberelieduponas
af orecast,research,orinvestmentadvice,isnotarecommendationorof f ertobuyorsellanysecuritiesortoadopt
anyinvestmentstrategy,andisnotintendedtopredictordepicttheperf ormanceof anyinvestment.Readersshould
notassumethatinvestmentsincompanies,securities,sectors,and/ormarketsdescribedwereorwillbeprof itable.
Investinginvolvesrisk,includingpossiblelossof principal.Thisdocumentispreparedbasedontheinf ormationLord
Abbettdeemsreliable;however,LordAbbettdoesnotwarranttheaccuracyandcompletenessof theinf ormation.
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