Andy D’Souza: Welcome back to The Investment Conversation. I'm Andy D'Souza, partner and chief marketing officer here at Lord Abbett. As part of our 2025 Midyear Outlook, we're going to talk with our investment leaders about key themes for the markets in the second half of the year across equities, municipal bonds, taxable fixed income, and private credit.

Today, we're going to speak with Lord Abbett's head of tax-free fixed income, Dan Solender. He's also a partner of the firm. Dan, welcome to the show.

Dan Solender: Thank you.

D’Souza: All right. Great to have you. Dan, last time we spoke here in the studio, we were recording the 2025 municipal bond outlook podcast in January. There was a lot of speculation at the time about how the policies of the new administration would affect major asset classes. Then we had the April 2nd tariff announcement, which led to, let's call it volatility across the markets, from which munis were not immune. So, like last time, let's start with the big picture.

I know that rates are near their high-end ranges over the last 15 years across the credit spectrum and maturity spectrum in municipals. But if you don't mind walking us through some of your thoughts around rates overall, supply, demand, and the credit fundamentals.

Solender: Sure. So, it's definitely been an interesting first third of the year. Definitely not how it was expected to go early on. Big changes with April, and even before that, just leading up to the whole tariff situation, there was a lot of conversation. So, kind of the backdrop on the year, as you mentioned, rates are the high-end of where they've been for the last 15 years, and that's really a key part of what's going on in the market right now.

And we started the year already at high rates, but rates have gotten even higher so far this year. And we've seen in the longer end of the market--yields 20 years-plus--yields go up even more than the shorter end, and even the shorter end has actually come down a little bit. So, the yield curve has gotten even steeper after being steep coming into the year.

So, the backdrop is, first thing, rates are high pretty much across the curve. Second thing, the yield curve is steep. Steeper. We've been steep for a couple years, at the steep end of where we are historically, and that's stayed the same so far this year and gotten steeper. Credit quality in the market is still very strong. We started the year at a very strong point. We're not at the peak we were at a year or so ago when all the money was coming in from the COVID stimulus, but we're still at very strong points for credit quality. More upgrades than downgrades [from major credit rating agencies].

And we're now just kind of in an environment where supply is still at record levels. We had a record amount of supply [of new municipal bond issues] last year, $500 billion plus, which is the first time we'd hit that number, and we're almost 20% ahead of that pace so far this year. So, supply has been very strong. Demand is another component, obviously an important component since more than 70% of municipal bonds are owned by individuals.

And we've seen demand on the separately managed accounts side be consistently strong like it has been for a few years, remaining very strong. Mutual fund flows had started the year picking up after kind of a slow couple of years. And then in April things turned a little negative for a few weeks, and they have slowly turned positive again. So, kind of recapping, yields on the higher end, yield curve steep, credit quality good, supply on the high side, demand good in certain parts of the market and kind of inconsistent in other parts of the market.

D’Souza: Yes, I guess to put it in perspective, Dan, you've been in the markets for 30 years, over 30 years at this point, and the volatility we saw, you mentioned in the first half of the year so far, how does that compare to other times you've seen the markets be volatile, in your experience, and anything you could learn from those times to put into practice today?

Solender: Sure. First of all, so far, it's been a short volatility moment. That's one thing that's a little different than what we've seen in the past, there really was not a long time period where there was that high-volume pressure on the market. It's very different from other ones, too, because you kind of look back at the credit crisis in '08, you kind of didn't know credit quality-wise what was happening and what the bottom was with all the housing issues and mortgage issues.

COVID hitting in 2020, another example where you just didn't really know what was going to happen to the economy. We hadn't ever been through something like that before. This time it was just man-made. It wasn’t like it was something that happened out of nowhere, or something that was kind of just building over time. Those tariffs were put on, and there was a shock to the economy because of that, or at least a projection of shock to the economy because of that, and the market had to react quickly to the change in the outlook.

So, I guess one thing that's a little bit different in munis than in past markets, too, is that we always have had mutual funds. Separately managed accounts have been building for the last 20 or so years. ETFs [exchange-traded funds] are kind of becoming a factor in the market, which we haven't seen the way they were before. They're still not a huge amount of the assets outstanding, but they've definitely more than doubled in size over the last five years. And the reason that's important is because a lot of market-timers now are using ETFs to come in and out of the market.

And that's kind of the biggest pressure we saw in April was that we had the biggest inflow days, the biggest outflow days, kind of back and forth, back and forth in terms of ETFs flows. And when that happens, they have to sell when they get outflows, and that really pressured the market. And that was really something different. Mutual fund flows did not turn as negative as they have in the past, so it seems like a lot of the market-timers are now using ETFs, which makes it a little different.

D’Souza: Got you. You mentioned the tariffs, I guess, and it's been volatile across all the markets, but when you think about municipal bonds, is your area a little more immune than the equity markets or your taxable fixed income counterparts, or what's different about it, I guess?

Solender: Obviously, no market is totally immune from it, but we definitely are more insulated than other markets. You kind of compare it to the corporate market, where we do have corporate bonds in our market, but an individual company can be hit hard by tariffs. And there's a little bit of that. Equities, that can be a big factor. You look globally at different things around the world that can be very hard hit.

A lot of the municipal bond credit is backed by things that you need to do every day. We're all still paying our income taxes. We're all still paying our real estate taxes. We're all still paying for water and sewer. We're all still paying for education if we need to. We're all paying for our toll roads. So, a lot of these things, tariffs are not going to affect, the credit quality is going to be strong. While we can't be totally immune from it, we are insulated a lot more than a lot of other markets, which you kind of look at almost any scenario for tariffs, whether we're at the toughest starting point, or where we're moving towards, we kind of view in any kind of tariff scenario [that] municipal bond credit really holds up pretty well.

D’Souza: Got it. And more broadly speaking, I guess, from the fiscal picture, in the last podcast we talked about it. The market does it every year. We talk about the questioning of the tax-exempt status of municipal bonds. I know it's come up recently. Any insights as to that conversation?

Solender: Sure. That's one of these things that no matter which party is in control of the federal government we go through budget discussions. It goes back to the '90s, it happens, and kind of happened when Obama was president, it's happening now with Trump as president that the negotiation over the tax-exemption of municipals is always thrown in there because there's this misperception that the only people benefiting from the tax-exemption are the investors who are high-net worth individuals getting the tax-exemption on their income.

But in reality, what's really going on, the bigger impact would be on everyone else in the country, because all the infrastructure is being financed at tax-exempt rates, which makes them lower. So, if the tax-exemption goes away, it's not like these projects go away. You still need all the infrastructure built. It would have to be at a higher rate. So that means your local income taxes have to go up. Your fees for water and sewer have to go up. Fees for utilities, fees for using airports, you name it, everything has to go up.

And that kind of hits more of the country a lot harder than it does high-net worth [individuals]. So we did see this coming up in the discussion again this time. And it was in there for a few months. The most recent bill proposed by Congress on the Republican side does not include limiting tax-exemptions. So, it looks like we've made it through another discussion of this and it's not going to be eliminated.

But at the same time, there are going to be marginal things that impact our market like, there's been a lot of focus on universities recently and kind of the pressure the administration is putting on them. One of the places the administration can raise revenue is by going after taxing endowments. There's already a small tax on some of the largest endowments, but that is pretty much 100% certain to increase and to have more universities subject to the endowment tax.

But at the same time, most of these are very high-quality institutions, very high cash [holdings], very strong market positions. We don't think there's going to be a material impact on credit from these changes, it just will be something that'll be in the news. And we might also see little things in other parts of the market. Maybe you might not be able to finance a major league sports stadium with tax-exempt bonds at some point, or something else in the private activity sector. But right now, the only thing that's really being mentioned is this tax on endowments.

D’Souza: Is it a large part of the market or a relatively small corner of the market in terms of the overall tax-free landscape?

Solender: Well, the education sector is under maybe in the range of 10% of the market, but the number of institutions that really will be subject to this tax is a fraction of that group. So, it's not a huge part of the market, and they are mostly triple- and double-A rated credits, so not a huge impact.

D’Souza: Got it. Another thing that's been in the news recently, as recently as this morning again, is the idea of the proposed changes in the tax rates. Where are we with that in your mind?

Solender: Strangely, there's been talk about raising the taxes on the wealthiest. It seems like that's not in there at this point. The biggest tax impact they're talking about right now is raising the cap on state and local taxes, which didn't exist until the last Trump administration where they capped at $10,000 the amount of tax that could be deducted on state and local taxes.

D’Souza: The SALT tax, right?

Solender: The SALT tax, yes. And it seems like the ceiling is going to go up on how much you can deduct. Not fully back to where we were before 2017. It should not be a major impact on the market. It's something that's going to be in there and benefiting some people but should not have a major impact on the market in terms of the attractiveness. And actually, one thing that could be interesting, too, with this whole endowment tax, is you might find universities might have more interest in tax-exempt bonds going forward, too, because now they're going to be paying taxes, it could be something new and that could more than offset the impact of raising the cap on state and local taxes.

D’Souza: Interesting. Thinking about the relative value of the ratio between Treasuries and municipals, what's the yield ratio today? What's that telling you about relative value? Do they look expensive? Do they look a little bit more attractive? What's the ratio telling you?

Solender: The starting point of looking at relative value is U.S. Treasury rates compared to triple-A municipals. And the important thing to remember about triple-A municipal yields are hypothetical these aren't real. Treasuries are real bonds and real yields. [The AAA muni rate] is an estimate, a benchmark. The rates of municipal bond yields to Treasuries kind of went up in April. We went through that outflow week or so and you're looking at the peak of the last year around the second week of April was the peak in terms of the ratio of munis to treasuries.

It's come down a little bit, but it's still on the higher side. The key thing, we always buy bonds at yields higher than the triple-A benchmark yield, but now that the starting point is higher, it's interesting because the long end of the market is particularly attractive [with the yield] over 90% of Treasuries. The intermediate part and short part are more in the 70s, in the mid-70s, which is cheaper than they've been in a while.

It kind of makes it look attractive versus other markets where we are right now. I'd argue that even if the ratios go back to where they were previously, we're still attractive because we're buying yields at much higher levels. But we are at a point right now, as a starting point of relative value, municipals are looking cheaper. And a lot of that has to do with that whole cycle back in April, which has kind of carried over a little bit.

We had a period of time in April when there were outflows, all those ETFs selling, and when munis get outflows, since a lot of the laws have changed in the last 10, 15 years, where dealers don't take as much inventory, banks and insurance companies have a lower corporate tax rate, so their demand for municipals is lower, rates have to move up quite a bit in munis to get the liquidity necessary from people in other markets like having insurance companies come back.

That kind of happened in April and it's come back a little bit from that because the market is not under pressure. The supply has come back. In a typical week, in a normal year, we have $7, $8 billion a week of supply, now we're gaining $12 to $15 billion. So, the answer is our supply is high, making us cheaper versus other markets, but we're kind of coming back from that liquidity crunch we had a few weeks ago.

D’Souza: Last time we also spoke about one pocket of the marketplace in the high yield municipals, specifically. How are they holding up in this volatility? Are you seeing increased volatility there? And/or are you seeing opportunities in that part of the market as well?

Solender: So high yield we think is a really attractive place to invest. The starting point for credit quality is strong. We're coming off a couple years--more than a couple years--where default rates have been extremely low, and they continue to be low. With high yield municipals, it's very different from taxable markets, because when most of the defaults happen, it takes time for them to happen. You'll see an issuer hit a reserve fund, and take money out of a reserve fund, or ask forbearance because they're breaking a [bond] covenant, so you kind of see it happening for a while.

And we're not seeing a lot of that happening right now. There are certain sectors like senior living where that's happening a little bit, but it's not happening in other areas where credit quality is strong. That kind of comes back to the supply/demand relationship which is a big part of the equation too because mutual fund flows were hit-- in 2021 there were record-low rates, record inflows [into muni-bond funds] over $100 billion, in 2022 rates were going up all year so $135 billion went out [of muni funds]. In 2023 about $10 billion went out.

So, it's slowly coming back. In 2024, about $40 billion came into munis, and so far, this year, we were up to about $10 billion, now we're back to about $5 billion in. But the key thing about that, last year was $40 billion, and this year is $5 billion, almost half of that is going into high yield funds in the mutual fund side. So, the main point there is that high yield demand is strong. Then, getting back to the supply side too, I mentioned record supply, and that's because a lot of issuers either have built up infrastructure needs coming out of COVID that they haven't gotten to because they were kind of not accessing the market for a while in areas like healthcare, transportation, or it's issuers like education trying to get ahead of whatever comes out of Washington and wanting to issue quickly.

So, it’s the investment grade side of that, which is having record supply. The high yield side is not having that much supply. It's just normal, even below normal, because rates have gone up so much compared to where they were five years ago. A lot of projects aren't economic. So, what's interesting about high yield is the credit quality is good, there are good supply and demand dynamics, and then getting back to the starting point of this whole thing is that the yields are attractive, and the spreads are still attractive. The extra incremental yield you're getting for high yield is very attractive compared to where you've been able to buy bonds historically.

D’Souza: Sounds pretty strong. Are there other areas that you find attractive in the marketplace outside of the high yield municipals in general across the landscape?

Solender: Starting from a sector standpoint, a lot of the sectors we really like investing in are the ones that are getting the heaviest supply [of new issuance], we like the revenue-bond side compared to general obligation bond. We have a very strong research group. We like doing the analysis. A lot of these things are areas where you can really project revenues and get comfortable with them. So, areas like healthcare, transportation, education, all areas that have seen a lot of supply, a lot of really strong investments to make in those areas.

We definitely like those. If you look at the municipal yield curve, pretty much every point in the yield curve is attractive right now. We went through a few years of having an inverted yield curve from about two to about 12 years. That inversion as of the start of 2024 disappeared and we're upward sloping again. So, you're getting compensated in the intermediate range. I already mentioned we're very steep out to the long end. So, no matter where you're investing in the market, it's good especially if you can take the volatility going out long, you know, 20-plus years, is very attractive, because it's so steep. There's a lot of extra income potential return, but there is volatility as we definitely saw in April what can happen, which is some volatility. Revenue sectors and if you can take it, the longer you can extend yourself on the yield curve right now, the better the potential benefits.

D’Souza: Thanks, Dan. You mentioned earlier the presence of ETFs in the marketplace. You talked about mutual funds as well. We went through some areas of opportunity across the credit spectrum and the maturity spectrum as well. You had a reference earlier to separately managed accounts or SMAs. One more access point for retail investors to get into the marketplace here. What are you seeing around supply and demand or just interest in people implementing SMAs in their portfolios?

Solender: SMAs are definitely the area of the most tremendous growth across any area of the market and have been for a couple of years now. It's a huge range of what people like in that market, because so much can be tailored to what people want and be customized. And people are going in a lot of different directions. We're seeing people going into an intermediate [maturity] strategy, really wanting to access that part of that market. We're seeing ladders. One of the biggest challenges people are running into is you have people who have been in money market [funds], CDs [certificates of deposit], T-bills [Treasury bills].

Those rates are finally starting to come down a little bit. And if they look at it compared to municipals, the yields look attractive in municipals. And one of the first steps to kind of get them out of [cash] and take a little more risk is to put them in ladders, and then in ladders you get attractive yields, and if you're worried about rates, if rates go up it's actually a good thing for you because that means your ladder reinvested at a higher rate.

So, we're seeing a lot of people move in that direction. And then also with SMAs, something people really like nowadays too, it is a place where you can take credit risk with a completion fund and investing in triple-B and lower quality bonds as a tag-along to a separately managed account. So, we're seeing the full range. The biggest growth is in intermediate and ladders; the long end and the lower quality tag-along of completion funds are also areas of huge growth.

But that SMA area, just because it's so tailored to what people want, and we can customize all kinds of things, that is the biggest area of growth in the industry.

D’Souza: Got you. And I guess as the market evolves, it's great to see we were able to adapt to those demands and deliver to the investor in the vehicle that they would prefer best, be it a mutual fund, be it a separately managed account. You can be agnostic to the vehicle and just make sure that you're adding value across the yield curve, maturity spectrum, and credit quality spectrum as well.

So, Dan, it sounds like if I want to recap a little bit here what we talked about today, overall, for tax-free municipal bonds in the U.S., it looks like strong credit fundamentals, strong supply. You mentioned the growth [in supply] last year of over a half a trillion dollars and even higher going forward this year. Strong demand, especially when it comes to things like, as you just mentioned, SMAs, and high yield municipals. Tariffs, although not immune to tariffs, tax-free bonds would be a little bit insulated, I think is the word you used. The everlasting debate of whether tax-free bonds will lose their tax-free status seems like it's again a lot of talk, but not in the end going to be something that looks like it will be going through. So that's good news in many ways.

As far as relative value versus Treasuries, [muni bonds are] still attractive in those ratios overall. And it looks like for areas of opportunity, you see things like revenue bonds, areas like healthcare, transportation, but across the yield curves you mentioned earlier, you're seeing rates near 15-year highs across all sectors of the marketplace. And so, at the margins, if you can, maybe go a little bit longer [in maturity] in some of the portfolios to the extent that your risk tolerance can handle that. But overall, it sounds like a pretty constructive marketplace for municipals going into the second half of 2025.

 And so, Dan, thanks again for the time today. I appreciate you sitting down with us.

Solender: Thank you. Thanks for having me.

D’Souza: This has been The Investment Conversation podcast. Thank you all for listening.