In the midst of a historically rough year in the $4 trillion municipal bond market, investment managers see ample opportunity as surging yields provide a compelling entry point.
Ten-year benchmark municipal bond yields are hovering around 3.23%, the highest since 2011, while 30-year munis are yielding more than comparable US Treasury debt. Those prices open the door for investors looking for income in a market where many state and local governments are flush with cash, said Sylvia Yeh, co-head of municipal fixed income at Goldman Sachs Asset Management and Brian Barney, managing director for institutional portfolio management and trading at Parametric Portfolio Associates, at a Bloomberg muni market panel discussion on Tuesday.
Conversations with clients now are “almost entirely opportunistic,” Barney said. “During times of volatility and attractive rates would be a good time to enter.”
Still, municipal bonds are down about 12% since January, on track for the worst year of performance since at least the 1980s, according to Bloomberg indexes. And the Federal Reserve is expected to continue raising interest rates to quell inflation, meaning that there is likely more pain to come.
In the following Q&A, shortened for clarity and brevity, the investors share their takeaways of 2022 and how they give insight into what next year may hold.
What sectors do you like in this market environment?
Yeh gave a one word answer when asked where she sees opportunity in the muni bond market these days.
“Everywhere,” she said, detailing there are “interesting” buys in high-yield debt when her team is comfortable with the credit fundamentals. On the flip-side “you can buy some pretty cheap high-grade names with spread, which you would want to do all day long up and down the curve,” she said.
Healthcare bonds are becoming attractive even as hospitals grapple with staffing expenses and the sunset of pandemic aid, Barney said.
“There’s definitely going to be some trouble in that sector, and so having a credit research team, as we do, can help uncover what more attractive spreads are from a year ago,” he said. “So that’s one sector where there’s risk but opportunity.”
Is there anything you don’t like right now?
“We like everything at a price,” Yeh said. “When spreads were so tight, as they were last year, maybe we wouldn’t play as much in project finance. But now as we’re starting to see some of the construction risk materialize, spreads widen and some of the deals break, they become more interesting at certain prices, they are valued where they should be.”
How are you dealing with the lack of liquidity in the market?
In recent years, dealers have been more reluctant to take risk, keeping their inventories of muni bonds low, which has resulted in less liquidity -- a trend Barney said the market is contending with.
“It’s like we’re numb to this year, and the lack of liquidity is the new norm,” he said. There’s been “more algo-bidders, more players in the odd-lot space. That liquidity would surprise you, it’s bigger than you think.”
Without a dealer backstop, there have been wider swings in muni bond prices, selling off rapidly during periods of stress like the early stages of the pandemic, Yeh said. The market bounced back quickly after non-traditional muni investors like insurance companies and foreign buyers stepped in, she said.
“We do have liquidity providers out there so long as our market has the ability to trade to levels that make sense,” she said.
“It’s interesting to see how our market is reshaping and how participants who used to be super active and maybe pushed to the sidelines a little bit because we weren’t as attractive, are coming back,” she said. “Hopefully there’ll be more consistent players in our marketplace.”
How is ESG being viewed in the municipal bond market?
The ESG market is still in its “early innings” phase, according to Barney, with most calls to clients being educational, but he anticipates growth in the sector.
Yeh emphasized that the process of tailoring investments to clients’ needs takes time, and it will take even longer for there to be pricing benefits for governments who sell ESG-labeled debt.
“I think we are far away from that,” she said. “I think we as market participants have a lot more to do before issuers can expect an impact on price. There’s not enough data, not enough client interest -- it will come -- but not yet.”
How concerned are you of the potential for recession?
“We’ve had the benefit of seeing this before,” Yeh said. “Whether it’s a recession or whether it’s Covid, you look at the resiliency behind the muni market.”
States and cities may be entering into a potential slowdown “in such a better place than they were in a very long time and that’s going to help them navigate through a recession which we expect to be on the lighter side, if and when that does happen,” she said.
Governments are seeing healthy tax-receipts, rainy-day funds and reserve balances making them “in the best shape they’ve been in decades,” Barney said. “We’re comfortable they’ll be able to weather the storm.”
There is the possibility that muni credit has “peaked” without the likelihood of additional federal aid, Barney said. “It’ll deteriorate certainly from here, it’s just to what extent? We would have a hard time seeing a severe deterioration.”
Bloomberg News provided this article. For more articles like this please visit
bloomberg.com.
Read more articles by Hadriana Lowenkron
