Download Seeing Value in Alternative Minimum Tax (AMT) Bonds

ZIEGLER CAPITAL MANAGEMENT
MARKET INSIGHT & RESEARCH
BPG Fixed Income
Seeing Value in
Alternative Minimum Tax (AMT) Bonds
Municipal bonds are typically viewed by the general public as being tax-exempt securities, not
subject to federal and, in some cases, state/local taxes. As a result, most investors in the asset
class tend to steer clear of municipal bonds subject to the alternative minimum tax (AMT) due to
concerns of potentially triggering a future tax liability. This may not be the most optimal strategy.
Paradoxically, for many high income investors, the taxability on an AMT bond is not guaranteed. For
those not subject to the AMT tax, the bonds may offer a significant gain in income and represent a
good relative value in the current low yield environment.
Municipal AMT Bonds
PUBLISHED:
For most investors, municipal bonds are viewed as tax-exempt securities, where
interest earned is not subject to federal and, in some cases, state/local taxes. Less
familiar are municipal AMT bonds. When securities sold by state and local
governments are used to finance projects that are not used to provide a benefit to
the general public, the bonds may be subject to federal taxes. Such bonds include
those issued for not-for-profit organizations and other “private activity” issuers, such
as airports, housing agencies, and corporations. As such, interest earned on “Private
activity” or municipal AMT bonds may be subject to federal taxes.
June 2016
WRITTEN BY:
Tommy Chan
Senior Credit Analyst
Due to the risk that interest earned on AMT bonds may become taxable, these
securities typically offer higher yields. However, it is shortsighted to believe that all
AMT bonds will become taxable for each investor. It depends on whether the
taxpayer is subject to AMT tax. That is truly a complicated and not intuitive process,
which bears analysis to find potentially hidden value.
What is the AMT Tax?
Essentially, the AMT tax was created to prevent taxpayers with very high incomes
from using available tax loopholes and certain tax credits to either pay no or very
little income taxes. The federal tax system has two parallel tax calculations to
determine how much you owe. First, there is the regular tax calculation with a
hierarchy of tax brackets, and then there is an AMT system which claws back
certain types of common exemptions/deductions and applies a flat 28% tax rate to
incomes over $185,400. Each year when personal income taxes are filed, every
taxpayer must pay the greater of the regular tax or AMT tax. For most, the parallel
calculation is invisible to us or performed through complex tax return software.
However, for others, it is a dreaded moment of discomfort.
1
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Phone: (312) 368-1442
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To determine whether a person may pay more through the AMT tax is complicated. There are many inputs used to
determine a person’s eligibility to the AMT tax. For instance, the AMT calculation disallows state/local tax
deductions and dependent exemptions when calculating taxable income (they are allowed to be deducted from
income when calculating the regular tax). As a result, families with children and people living in high-tax states are
among the most likely to be subject to the AMT. If a taxpayer is subject to the AMT tax, then interest earned on a
municipal AMT bond is included as taxable income.
Myth: All High Earners Are Subject to the AMT
Municipal investors tend to avoid AMT bonds due to concerns of triggering a tax liability. However, it is incorrect to
assume all high income taxpayers are subject to the tax. While it is true that taxpayers with higher earnings are
more susceptible to the AMT, this is only correct up to a certain tax bracket. Where the marginal rate begins to
exceed the flatter AMT structure, we actually see the amount of AMT taxation begin to fall. For the $200,000 to
$500,000 income range, 63% of filers were subject to the AMT (Figure 1). This declines to 44% for the $500,000
to $1,000,000 income range and 18% for filers in the $1,000,000 or more.
FIGURE 1: TAX RETURN SUBJECT TO AMT BY INCOME LEVELS
Num ber of
Total Tax
Returns Filed
Incom e Level
Num ber of Tax
Returns Subject % of AMT
R eturns Filed
to AMT
All returns, total
147,351,299
3,940,304
3%
$1 to $75,000
110,680,488
50,986
0%
$75,000 to $100,000
12,574,107
71,883
1%
$100,000 to $200,000
16,425,446
623,782
4%
$200,000 to $500,000
4,488,110
2,805,692
63%
$500,000 to $1,000,000
724,251
317,475
44%
$1,000,000 or more
345,883
62,219
18%
So urce: IRS, Statistics o f Inco me Divisio n, P ublicatio n 1304. Data sho wn is fo r 2013 returns; Ziegler B P G Gro up.
Geography Matters
A taxpayer’s state of residence plays a key role in determining if he or she is subject to the AMT tax. For instance, in
high tax states, such as New York and California, there is a higher likelihood for a taxpayer to be subject to AMT
versus a low tax state, such as Texas (Figure 2). In Texas, only 3% of all taxpayers were subject to AMT and 19% for
those with incomes over $1 million. In New York, the likelihood increases to 5% and 48%, respectively.
2
FIGURE 2: ALTERNATIVE MINIMUM TAX BY STATE
State
New Jersey
Connecticut
New York
Massachusetts
California
Maryland
Virginia
Illinois
Minnesota
Rhode Island
Oregon
Pennsylvania
Colorado
Vermont
Georgia
North Carolina
Ohio
Delaware
Nebraska
Wisconsin
New Hampshire
Maine
Kansas
Iowa
Utah
Returns
Subject
to AMT
(%)
5.90
5.50
4.90
4.70
4.40
4.40
3.50
3.20
3.10
2.70
2.60
2.50
2.40
2.30
2.20
2.20
2.20
2.20
2.20
2.10
2.10
2.00
1.90
1.90
1.80
Income
Levels
$1,000,000 Rank in State
or More
Tax Rate
Subject to
AMT (%)
33.60
4
30.80
15
48.20
8
30.80
30
44.40
1
33.20
27
25.50
27
24.30
42
33.80
3
31.90
21
46.20
2
22.90
44
32.70
38
48.90
6
25.90
21
32.80
27
29.60
31
32.10
18
34.60
17
31.40
10
30.30
31
42.50
12
28.40
39
33.30
4
30.60
31
Rank in State
Median
Household
Income
2
4
15
6
9
1
8
17
10
18
28
21
14
20
31
40
33
12
25
22
7
34
27
23
13
State
Michigan
Montana
Missouri
Hawaii
Texas
South Carolina
Louisiana
Idaho
Kentucky
Oklahoma
Washington
North Dakota
Arkansas
Arizona
Florida
Indiana
New Mexico
West Virginia
Wyoming
Mississippi
Alabama
Nevada
South Dakota
Alaska
Tennessee
Income
Levels
Returns
Rank in
$1,000,000
Subject to
State Tax
or More
AMT (%)
Rate
Subject to
AMT (%)
1.80
22.40
41
1.80
38.00
16
1.80
26.10
21
1.80
44.70
9
1.70
18.90
46
1.60
32.70
13
1.60
19.30
21
1.60
41.20
11
1.60
32.20
21
1.60
22.50
31
1.60
26.40
46
1.60
21.80
45
1.50
28.80
13
1.50
28.60
40
1.40
28.40
18
1.40
24.40
43
1.20
32.50
37
1.20
26.30
20
1.20
34.10
46
1.10
23.30
31
1.00
23.20
31
1.00
27.00
46
1.00
23.60
46
1.00
15.70
46
0.90
20.40
21
Rank in
State
Median
Household
Income
32
39
36
5
24
42
43
37
46
41
11
19
49
30
38
35
44
48
16
50
47
26
29
3
45
Source: IRS; Bloomberg; Ziegler BPG Group. Tax return data shown is for 2013 returns. Tax return data for income levels $1,000,000 or more is for 2012
returns. State tax rates are for 2016. Median household income data is for 2015.
AMT Bonds Offer Extra Yield
Given the natural tendency of municipal investors to shy away from AMT bonds, these securities can offer higher
yields than the traditional non-AMT municipal bond with equivalent credit quality. While spreads have compressed
since last year, AMT bonds currently still offer yields 30 basis points over their non-AMT equivalents (Figure 3). For
taxpayers not subject to the AMT tax, we believe the extra yield offers value in the current low yield environment.
For example, the airport sector is one of the largest issuers of AMT bonds offering good value given the essential
nature of these credits with strong and stable credit fundamentals.
FIGURE 3: MUNI YIELD VS. MUNI AMT YIELD
4%
3%
2%
1%
AMT Muni Yield
Non-AMT Muni Yield
Source: Barclays Muni Index and Muni AMT Index data; Ziegler BPG Group.
3
Conclusion
It’s a common misconception to think that all high income earners are subject to the AMT tax and should avoid
AMT municipal bonds. There are many factors that go into determining a person’s AMT status. It largely depends on
the person’s tax bracket and the state that one lives. In the current low rate environment, we believe AMT bonds
offer value for some investors that are not subject to the tax. AMT bonds offer additional yield without exposing the
investor to greater credit risk. Notwithstanding, each investor’s tax situation is unique and must be evaluated to
determine their AMT status, which may change over time. It is also interesting to note that a tax that was originally
created to target only the highest income earners now no longer even hits those highest income brackets the
hardest. Today, it is the taxpayers beneath the highest brackets that have the highest likelihood of paying AMT.
The BPG Group at Ziegler Capital Management, LLC actively manages Core Municipal, Tax-Responsive, and Core
Taxable Strategies. Our approach balances a client’s objectives – income, risk, capital preservation, and
appreciation – rather than focusing on an income target without measurement of relative risk.
Reid Smith, CFA
Tommy Chan
CIO, BPG Fixed Income
Senior Credit Analyst
Senior Portfolio Manager
[email protected]
[email protected]
(212) 328-1091
(212) 328-1631
Daphne Car
Dan Urbanowicz
Senior Portfolio Manager
Portfolio Manager
[email protected]
[email protected]
(212) 328-1089
(212) 328-1634
DISCLOSURES
This material is based upon information that we consider reliable, but we do not represent that it is accurate or complete and it should not be relied upon as such.
Opinions expressed are our current opinions as of the date appearing on this material only. No part of this material may be duplicated or redistributed without Ziegler
Capital Management’s prior written consent.
Past performance does not guarantee future results.
This commentary expresses opinions about the direction of market, investment sector, and other trends. The opinions should not be considered predictions of future
results. Information contained in this report was obtained from sources usually deemed reliable, but ZCM does not guarantee or imply its accuracy, completeness, or
suitability for any specific investor. Information in this report is for informational purposes only, and does not constitute a recommendation to buy or sell any investment
management strategy or any specific security, commodity, or derivative contract. When investing in bonds, it is important to note that as interest rates rise, bond prices
fall. Investing involves risk, including the possible loss of principal invested.
Neither Stifel, nor its affiliates, provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.
Document Number 16-09041
4
About Our Firm
Ziegler Capital Management, LLC is based in Chicago, IL with additional offices in New York, New York, San
Francisco, California, St. Louis, Missouri, and Milwaukee, Wisconsin. The firm manages portfolios across
the fixed income and equity spectrum for a wide range of clients including corporations, mutual fund subadvisory, municipalities, pension plans, foundations, endowments, senior living and healthcare organizations
and high net worth individuals. Ziegler Capital Management was formed in 1991 and has grown significantly
in recent years through strategic business combinations with experienced investment teams nationwide.
Through these combinations, we have expanded our investment strategy offerings and broadened our
portfolio management teams to best serve our expanding client base.
Strategies
Other Market Insights
Periodic Table: Fixed Income Sector Performance
PERIODIC TABLE
Fixed Income Sector Performance Analysis
ANNUAL PERIODS
2006
2007
Emerging Mkts Emerging Mkts
13.89%
16.77%
High Yield
11.77%
Term Loans
7.33%
TIPS
11.59%
Treasury
9.59%
Global Credit
7.17%
Agency
8.03%
REITs
5.74%
Global Credit
7.29%
2009
2010
2011
2012
2013
2014
2015
3 YEAR
5 YEAR
10 YEAR
High Yield
57.51%
CMBS
18.35%
TIPS
14.10%
High Yield
15.58%
High Yield
7.42%
Muni
9.78%
Muni
3.55%
Muni
3.35%
Muni
5.65%
High Yield
6.81%
High Yield
15.19%
Treasury
13.09%
REITs
11.87%
REITs
14.58%
Muni
11.19%
Global Credit
11.06%
Agency
9.69%
MBS
8.30%
REITs
54.01%
Term Loans
44.87%
TIPS
- 1.13%
CMBS
27.85%
Muni
- 3.95%
Emerging Mkts
20.68%
Term Loans
9.97%
Invest Grade
- 6.82%
Invest Grade
19.76%
Emerging Mkts Invest Grade Emerging Mkts
11.86%
7.51%
11.05%
Invest Grade
9.52%
Term Loans
6.15%
Treasury
8.12%
ABS
0.91%
REITs
7.87%
CMBS
0.40%
Invest Grade
7.51%
REITs
1.55%
REITs
5.64%
REITs
6.12%
Term Loans
2.57%
High Yield
4.84%
Invest Grade
5.25%
MBS
2.00%
REITs
3.08%
Invest Grade
4.55%
CMBS
5.03%
CMBS
4.18%
Term Loans
4.09%
Agency
0.99%
CMBS
1.94%
Term Loans
9.43%
Treasury
0.51%
Invest Grade
1.73%
Term Loans
3.76%
Treasury
6.41%
MBS
6.14%
CMBS
9.07%
MBS
- 1.39%
CMBS
4.33%
ABS
0.42%
High Yield
1.64%
Treasury
3.66%
MBS
4.65%
Global Credit
- 8.29%
Muni
14.45%
TIPS
6.34%
Agency
5.27%
TIPS
7.33%
Invest Grade
- 1.46%
Agency
4.04%
Term Loans
- 0.38%
Treasury
1.11%
MBS
2.93%
Treasury
4.56%
Muni
4.96%
Muni
3.29%
CMBS
- 20.16%
ABS
10.62%
Global Credit
6.01%
Global Credit
4.47%
Muni
7.26%
Agency
- 1.79%
Global Credit
3.15%
Invest Grade
- 0.63%
Agency
1.05%
Global Credit
2.89%
Global Credit
4.38%
Invest Grade
4.38%
High Yield
2.19%
ABS
- 21.11%
TIPS
10.03%
MBS
5.67%
High Yield
4.38%
ABS
3.03%
Muni
- 2.89%
High Yield
2.50%
TIPS
- 1.71%
ABS
0.97%
TIPS
2.65%
TIPS
3.99%
Agency
4.37%
REITs
2.10%
High Yield
- 26.39%
MBS
5.76%
ABS
5.02%
Term Loans
1.82%
MBS
2.59%
Treasury
- 4.87%
Term Loans
2.06%
Global Credit
- 3.77%
Global Credit
- 0.21%
Agency
2.16%
Agency
3.81%
Treasury
2.58%
Term Loans
1.88%
REITs
- 27.76%
Agency
0.90%
Agency
4.61%
ABS
1.43%
Agency
2.44%
Emerging Mkts
- 5.94%
ABS
1.59%
High Yield
- 4.64%
TIPS
- 2.36%
ABS
1.47%
Emerging Mkts
3.50%
TIPS
0.49%
ABS
- 4.02%
Term Loans
- 28.75%
Treasury
- 7.41%
Muni
2.25%
Emerging Mkts
- 1.98%
Treasury
2.38%
TIPS
- 9.35%
Emerging Mkts Global Credit
- 7.16%
19.18%
MBS
6.07%
MBS
1.46%
Invest Grade
10.37%
CMBS
4.98%
Invest Grade
4.64%
MBS
6.96%
Global Credit
0.11%
CMBS
1.13%
REITs
7.38%
CMBS
6.20%
MBS
5.32%
CMBS
4.98%
ABS
5.43%
INSTITUTIONAL INVESTORS
ANNUALIZED
2008
Treasury
17.81%
REITs
- 0.03%
TIPS
4.49%
Emerging Mkts Emerging Mkts
- 8.37%
- 9.80%
Emerging Mkts Emerging Mkts
- 8.05%
- 3.29%
Muni
4.84%
ABS
- 0.02%
Source: Merrill Lynch
Ziegler Capital Management, LLC is a wholly owned subsidiary and affiliated SEC Registered Investment Adviser of Stifel Financial Corp.
This commentary is for institutional advisory clients of Ziegler Capital Management, LLC. The review often expresses opinions about the direction of market, investment sector and other trends. The opinions should not be considered predictions of
future results. The information contained in this report is based on sources believed to be reliable, but is not guaranteed and not necessarily complete. Past performance is not necessarily indicative of future results. Indices are unmanaged, do not
reflect fees and expenses and are not available as direct investments.
© Copyright 2016 Ziegler Capital Management, LLC | 16-02044 | Printed Internally
ZIEGLER CAPITAL MANAGEMENT, LLC
The chart provides a detailed look at Fixed Income
performance over the past decade, broken down by
13 sectors.
WWW.ZIEGLERCAP.COM/INSIGHTS
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ZIEGLER CAPITAL MANAGEMENT
MARKET INSIGHT & RESEARCH
Covered Call Investing and its Benefits
in Today’s Market Environment
Covered Call investing has attracted a great deal of attention from investors searching for lowervolatility equity strategies. The risk-reducing characteristics of the covered call strategy have
produced superior risk-adjusted returns over time relative to a long only approach. This paper
begins by discussing why an investor would allocate to a covered call strategy. The second section
of the paper describes three different types of covered call strategies: 1) Passive Index-based, 2)
Active Index-based, and 3) Active Single-stock.
Why Covered Call?
Written By:
•
A Low Volatility Equity Strategy with an Attractive Sharpe Ratio. Equity investors
are exposed to a great deal of volatility within portfolios. Although committed to the
growth prospects of the equity asset class, many investors may be willing to trade
this volatility for greater return consistency. Due to the income from the sale of call
options, which help stabilize returns, covered call strategies have tended to produce
lower beta and lower volatility compared to equities. Despite the lower beta, covered
call strategies have tended to produce returns similar to equities over the long term,
resulting in an improved risk-return profile.
Wiley D. Angell
•
Reduced Drawdowns. Investors often consider the sale of the call option as a form of
downside protection. As a result of the call premiums, covered call strategies tend to
outperform during bear markets, thus reducing portfolio drawdowns. Investors have
realized that equity returns can compound to higher returns over time by minimizing the impact of drawdowns. The downside protection is equal to the upfront call
premium received. The amount of downside protection, and the beta of the overall
covered call portfolio, can be tailored to client risk tolerances and return objectives.
Chief Investment Officer FAMCO Group,
Senior Portfolio Manager
Sean C. Hughes, CFA
ZIEGLER CAPITAL MANAGEMENT
Web: zieglercap.com
MARKET INSIGHT & RESEARCH
Published:
March 2016
Written By:
Tommy Chan
Senior Credit Analyst
Demand Strong Heading Into Seasonal Supply Uptick
www.zieglercap.com
INDIVIDUAL INVESTORS
We offer both equity and fixed income retail
strategies to the financial advisor community
in addition to custom private client solutions.
Phone: (312) 368-1442
Spring Season Comes to Municipals
Municipal bond demand remains quite healthy. Year-to-date municipal fund flows are
the second highest in the past five years with a streak of 24 straight weeks of
positive flows (Source: Lipper, JP Morgan, as of 3/16/16). The strong demand
backdrop is a positive technical factor as we move into the heaviest part of the
municipal issuance calendar. Compared to the same period last year, debt issuance
for the first two months of 2016 is down 13% (Figure 1). We expected a decline
driven primarily by lower refunding volumes (-33% from last year), compared to a very
robust period of refunding debt issued in 2015. Unexpected was the size of the new
money issuance to fund capital projects, which increased a solid 21% over last year
and 27% versus the prior five-year average. The increase in new money financing, led
by local government issuers, is a welcome improvement to the lackluster borrowing
in recent years. As municipalities struggle to balance pension funding costs, the
recent uptick in new money borrowing is worth monitoring. It may signal renewed
confidence in their fiscal health or potentially deferred capital needs are reaching a
critical nature and can no longer be delayed. We remain watchful as the market is
currently underestimating the potential for greater new money issuance this year.
A closer look at covered call investing and how it
could benefit your portfolio.
70 West Madison Street
Suite 2400
Chicago, Illinois 60602
BPG Fixed Income
A perceived safe haven from volatility in the global financial markets is
driving strong fund flows to the municipal asset class. The
attractiveness of tax exemption on a federal and, in some cases, state
level is a powerful benefit to individual investors. In today’s investment
landscape, municipals represent a store of value. Despite the strong
demand, we remain cautiously optimistic about large headline credit
risk. Pension funding needs remain significant for state and local
governments. Rising pension costs are offsetting the significant
savings issuers are receiving by refinancing legacy debt. The recent
uptick of new money issuance year-to-date is noteworthy. Whether
issuers are gaining more confidence to take on additional capital
investment remains to be seen. Lastly, political risk in the municipal
market cannot be underestimated. For two states – Illinois and
Pennsylvania – political gridlock is causing significant credit
ramifications for entities that rely on state funding.
Covered Call Investing
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The Basics of Covered Call Investing
By simply writing call options, investors can change the risk-return characteristics of
the equity asset class, creating a more stable return pattern over time. The premium
generated from the sale of call options provides an income component that can help to
stabilize overall returns, as shown in Figure 1. Equity investors are exposed to a great deal
of volatility within portfolios. Although committed to the growth prospects of the equity asset
class, many investors may be willing to trade this volatility for greater return consistency.
LEARN MORE
Senior Portfolio Manager
A Low Volatility Equity Strategy with an Attractive Sharpe Ratio - Investors have broad
familiarity with the S&P 500 Index, as it is the most widely used equity benchmark in the
U.S. Imagine taking the S&P 500 Index and selling a one-month, at-the-money call option
each month. Continuing to hold the S&P 500 Index and selling an index call option month
after month would create what’s known as the CBOE S&P 500 BuyWrite Index (“BXM
Index”). The BXM Index is the most widely used benchmark for covered call portfolios.
We offer a full range of fixed income and
equity strategy management to our TaftHartley, Health Care, Public Fund, Corporate,
and Endowment and Foundation clients.
Spring Season Comes To Municipals
The perceived safe haven from volatility in the
global financial markets is driving strong fund flows
to the municipal asset class.
LEARN MORE
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1
ZIEGLER CAPITAL MANAGEMENT, LLC
CONTACT US
70 West Madison Street | Suite 2400 | Chicago, IL 60602
www.zieglercap.com
312-368-1442
[email protected]
Ziegler Capital Management, LLC is a wholly owned subsidiary and affiliated SEC Registered Investment Adviser of Stifel Financial Corp.
Past performance does not guarantee future results. Indices are unmanaged, do not reflect fees and expenses and are not available as direct investments. This commentary often expresses
opinions about the direction of market, investment sector, and other trends. The opinions should not be considered predictions of future results. The information contained in this report is
based on sources believed to be reliable, but is not guaranteed and not necessarily complete.
© Copyright 2016 Ziegler Capital Management, LLC | 16-02010 | Printed Internally