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Fixed-Income Insights

An analysis of key data points for 2016 can provide a clearer understanding of important trends in muni-market activity—and areas of future opportunity. 

 

In Brief

  • We think an examination of key trends in the municipal bond market—based on data for 2016—can help investors become more comfortable with how the muni market operates.
  • With that in mind, this article compiles seven important facts about the municipal bond market, with an analysis of each. Our observations cover important developments in:
    –Trading volume by market type
    –Institutional and retail trading patterns
    –Time patterns in market activity
    –The number, and type, of muni bonds being traded
    –Activity in securities from the biggest muni issuers
    –Characteristics of the most widely traded issues
    –Types of key market participants
  • The key takeaway—We believe it would be beneficial for muni investors to carefully study the information compiled herein to help them be better prepared to identify opportunities in municipal securities.

 

The U.S. municipal bond market has evolved tremendously over the past 20 years.  One of the most important changes occurred during the late 1990s, when the Municipal Securities Rulemaking Board (MSRB) required dealers to disclose trade information within 15 minutes of the trade occurring.  Prior to this change, market participants relied upon communication with dealers for details about completed trades since the information was not widely disseminated.  Over time, more information has become available, and the MSRB created a website with up-to-date trading data.  These were revolutionary changes for the municipal bond market, and helped attract more participants because they were no longer at an information disadvantage. 

Now, of course, the amount of available information has been greatly expanded. At the end of each year, the MSRB publishes a fact book that compiles data about the prior year—and much of it is fascinating (to us at least) and quite instructive for those who want to learn more about how the market functions. 

But which information should investors focus on? Drawing on the MSRB and other sources, this column presents seven illuminating facts—with accompanying data points—about the municipal bond market from 2016.1 We think this “by the numbers” approach to understanding munis can help investors become more comfortable with how the market operates, and potentially help them to identify attractive investment opportunities.

1. Trading Volume Was Solid, Especially in the Secondary Market

Overall, the market value of municipal bonds outstanding was approximately $3.8 trillion on December 31, 2016, according to Federal Reserve data (which is updated quarterly).  Nearly two-thirds of the bonds are owned by individuals, either directly through owning individual securities or by having separately managed accounts or mutual funds.  During 2016, the total amount of municipal bonds that customers purchased was $1.6 trillion.  This does not mean that a significant portion of the outstanding bonds were issued last year. Instead, it represents the total par value of bonds purchased through new issues or secondary trades, as some bonds traded multiple times between accounts. 

To get a sense of how many of these purchases were in the secondary market, data from The Bond Buyer show that the volume of new bonds issued during 2016 was $445 billion.  There also was $36 billion of new short-term notes brought to market.  So, after subtracting these from the $1.58 trillion of customer purchases, it is clear that there were a lot more bonds bought in the secondary market than the primary market.  The total purchase volume during 2016 was the highest since 2012.

2. Institutional and Retail Trading Patterns Differed

Now, let’s look at the actual number of muni bond trades rather than the par value. When including both buys and sells, there were 9,358,046 trades during 2016.  Of the total, 3,796,034 were customers buying, 1,917,322 were customers selling, and the rest were trades among dealers.  On average, there were 37,135 trades per day for a total average daily trading par value of $12.4 billion. The interval of the day with the highest par value of trading was 10:45–11:00 a.m. ET, but the number of trades was fairly evenly dispersed between 10:30 a.m. and 4:15 p.m.  This tells us that a good portion of larger institutional trading is transacted during the morning, while retail trades with individuals occur consistently throughout the day.  It also suggests that dealers buy bonds from institutional investors primarily in the morning and then often re-trade them to individuals throughout the rest of the day.

3. Muni Market Activity Tended to Peak around Midweek

Let’s take a slightly longer view of the trading activity to examine weekly trends for 2016.  The highest average par value of bonds traded was on Thursdays, with $15.1 billion of volume.  Next highest was Wednesday, at $14.7 billion, with Monday being the lowest at $9.4 billion.  It is interesting that the largest average number of trades occurred on a different day— Wednesday—with 40,666, with Tuesday being next highest and Friday, perhaps not surprisingly, being the lowest, with 30,945.  Based upon these numbers, both institutional and retail investors are most active during the middle days of the week.

4. Lots of Different Bonds Were Bought and Sold

Within those daily trading figures, a surprisingly large number of individual bonds were changing hands. The average number of unique municipal bonds trading was highest on Wednesdays, with 14,032, and was lowest on Fridays, with 11,130.  This figure represents how many different bonds with different CUSIP security IDs were traded each day. 

It is interesting to compare the number of unique municipal bonds trading to securities in other markets.  For example, when you think about equity indexes, the S&P 500® Index has 500 different underlying stocks, and the NASDAQ Composite Index has approximately 3,000. That’s a total of about 3,500 securities. The muni trading data in the preceding paragraph only represent the total number of securities trading each day, and represent just a fraction of the unique bonds actually outstanding.  The market value of equities is larger, but the number of securities traded is much higher in municipals—which is testament to how widely they are used across America to finance governments, schools, airports, highways, hospitals, and other essential functions for both large and small municipalities.  Also, it makes clear that investment research is critical to differentiate the credit quality among the large range of issuers.

5. New Bonds Traded More Frequently Than Old Bonds

Another interesting way of looking at the market is how many of the bonds trading are from recent new issues.  Many municipal bonds remain in portfolios permanently, and never trade or at least rarely trade.  It turns out that 55% of the par value of bonds traded during 2016 was from bonds issued during the trailing 12 months.  For example, this means that more than half the bonds trading during February 2016 (on a par-value basis) had been initially sold into the market since February 2015 or later.  Only about 4% of the par-value trading in February 2016 was from bonds issued more than 10 years ago. 

The numbers are a little different when reviewing number of trades rather than par value.  Only 35% of the trades occurring are from bonds issued during the last 12 months.  This tells us that institutions do more trading with recently issued bonds, since they typically have larger, average-sized trades that allow the market value to be higher for recently issued bonds, even though the actual number of trades is lower.  They do not trade older bonds anywhere near as frequently.

6. Money Market Securities, Big Issuers Dominated Trading Stats

The most actively traded bonds by par value in the muni market in 2016 were mostly money market securities.  Of the top 10, only one is a fixed-rate, long-term bond: the large Puerto Rico general obligation (GO) bond issued three years ago, which currently is rated ‘Caa3’ by Moody’s and ‘D’ by Standard & Poor’s, since it is in default.  Money market securities trade each day at par, with their coupons adjusting to yield movements rather than their prices moving as mutual funds trade them daily to manage cash.  So, while these are the most active, they are not a great representation of muni market activity.

When reviewing the most active by number of trades, the highest was 8,092 trades for a bond issued by Saint John Baptist Parish (Louisiana) for Marathon Oil, which is rated ‘Ba1’ by Moody's and ‘BBB-‘ by Standard & Poor’s.  It is a bond with a 5.125% coupon, a 2037 maturity, and a short call date, so it is a structure that is attractive to individual investors. Many of these trades were smaller transactions involving purchases by retail buyers.  Others on the top for highest number of trades were several GO issues from Illinois, and individual GO bonds from Puerto Rico and Pennsylvania. The New York Municipal Water Authority and the New Jersey Transportation Trust Fund also were high on the list.

When removing money market securities and ranking by highest volume of par value traded, the top is the Puerto Rico GO (mentioned previously).  The second highest is a Massachusetts GO bond, with a 4% coupon and a maturity of 2042, rated ‘Aa1’ by Moody’s and ‘AA+’ by Standard & Poor’s.  This is a structure that typically has strong demand from retail investors due to the lower coupon and price close to par.  The other issuers high on the list are GOs from California (several issues), Illinois, the New York Transportation Development Corporation for LaGuardia Airport, and Los Angeles (two bonds).

One thing that is clear from reviewing the list of the muni bonds with the highest trading volume by par value is that it is dominated by many of the larger issuers.  Issues from California and New York typically are high on the list, which is not surprising, given the population of each state.  The Puerto Rico bond is high because hedge funds have been actively trading that bond and their portfolios have high turnover.  Illinois GO bonds have the highest yields of all the states, so many institutional investors have been adjusting their positions both up and down based upon their credit outlook.  Also, many individual investors have been attracted to the higher yields. 

Still, these are just the largest trading names and do not represent anywhere near the full universe of investment opportunities in the municipal bond market, although they probably are among the most liquid.  If an investor were to review fund or separately managed account holdings, he or she would see a large, diverse set of issuers separate from the larger ones on this list.  These smaller issuers can provide attractive value and often less volatility to investment firms that have the resources to research the full range of sectors and can diversity an investor’s portfolio.

7. Dealer Base Dwindles, but Smaller Investors Still Predominate

To round out our list of the data points with the biggest potential influence on investor decision-making, here are two more. First, the number of dealers registered to trade municipal bonds has dwindled.  During 2012, there were 1,787, but as of October 2016, the list was down to 1,448.  This is still a good number of dealers (many of them are small in size), but the list is slowly shrinking and trading volume by par value is increasingly dominated by the larger firms. 

Second, there are a lot of municipal bond trades each day, but many of them are small.  Of the average daily number of 37,135 trades during 2016, 965 were for par value $2 million or higher, while 582 were par value of $1–2 million.  On the small side, 17,739 were $25,000 or lower in par value, and 7,329 were between $25,001–50,000.  This means that more than half the trades were for values less than $50,000.  These trades were not necessarily made by just individual investors, because many institutions buy smaller positions to construct separately managed accounts or to grow institutional positions for their funds, but still, individual investors represent a large portion of these trades.  This notion that some individuals are still actively buying bonds rather than selecting an investment manager is an interesting point to consider, given the market value impact from increased volatility in credit ratings in recent years and the wider bid/ask spreads for smaller trades.

Summing Up

Based upon these statistics, it is clear that the municipal bond market is active and has many attractive opportunities.  It also is clear that it is quite unlike other asset markets, given the large number of issuers, the trading patterns, and the range in sizes or volumes of trades.  Given the unique trading patterns and investments, it is beneficial for investors to carefully study the information in order to be prepared when investments with attractive relative values emerge.  With the MSRB’s material data upgrades, investors have much more information available to help them understand the intricacies of the municipal bond market.

 

1Unless otherwise noted, data presented herein are from the MSRB 2016 Fact Book.

 

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