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Fixed-Income Insights

How did the municipal bond market perform during 2015—and why is it not easy to keep track of how the market is performing?

 

In Brief

  • There is a comparative paucity of daily information about fixed-income markets compared to other asset classes. This is especially true of the municipal bond market. So how might investors gauge the performance of the muni market in 2015?
  • There are some measurements investors can use to gauge relative performance. One broad measure is yield changes for maturities along the yield curve comparing U.S. Treasury securities to a muni-bond benchmark. For 2015, in most maturities, muni yields fell, while Treasury yields rose.
  • As for specific fixed-income sectors, investors might wish to compare movements in the ratio of municipal bond yields to corporate bond yields, and the ratio of yields in the high yield portion of the municipal market versus those of corporate high yield bonds. 
  • The key takeaway—There are several closely monitored indicators that clearly show that the municipal market performed well and differently from taxable fixed-income markets during 2015, while still representing value today.

 

When following market updates from financial news sources, investors try to get a general sense of market performance based upon the indicators that are being reported. With equities, media outlets typically cite benchmarks such as the S&P 500® Index, the Dow Jones Industrial Average, and the NASDAQ Composite Index. The commodities market is often represented by price movements in gold and oil. For international markets, the financial media frequently quote foreign currency figures comparing the U.S. dollar with counterparts such as the euro and the yen, or international equity-market returns. 

But when the media turns its attention to the bond sector, which comprises a variety of markets around the country, and the world, with trillions of dollars in assets outstanding, it often simply quotes the yield on the 10-year U.S. Treasury note. If you are lucky, reports might mention the price movement for the 10-year Treasury note as well. That is about it. 

So, for investors who don’t have terminals in front of them flashing market information, or who don’t receive regular messages detailing bond offerings or bids, it is difficult to know what is really happening in the bond market. At the end of the day, investors can check net asset value (NAV) changes for their fixed-income mutual funds. But that’s only a single snapshot; it will not tell you if there was a lot of volatility in the portfolio, or if lower-rated bonds outperformed, or if a specific bond had a large price movement.  Even with municipal bond ETFs (exchange-traded funds), the price movements throughout the day typically have been determined through algorithms based upon taxable bond market activity rather than municipal bond market trading. The scant information about bonds provided in market coverage is not an oversight by media outlets, but rather reflects the desire to focus on the markets that the media think they will garner the biggest audience.

Keeping Track
Given this environment, it frequently is difficult for investors to get updated information about how the municipal bond market is performing during the trading day. The Municipal Securities Rulemaking Board (MSRB) has made great efforts to ensure that muni-bond dealers report all their trades electronically, and the board has created a website called EMMA, wherein investors can see a constant flow of trade information. Still, there are tens of thousands of trades in the municipal bond market each day, and it is tough to parse them to know which ones represent the general tone of the market and which ones reflect information that is unique to a particular security, or group of securities, and don’t apply to the whole market.

In reviewing relative 2015 mutual fund performance, it is clear that the municipal bond market performed well compared with other markets. This, however, is not accurately reflected in data from performance measurement services such as Lipper and Morningstar, which don’t accurately present the returns of municipal bonds compared to other assets because the services don’t adjust the returns to include the advantage of earning tax-exempt interest. These providers present the returns without adjusting the municipal bond yield to calculate the tax-equivalent yield, reflecting how much an investor would need to earn on a taxable bond to get the same aftertax return. If those calculations were included, actual relative municipal bond performance would be even more impressive.

Since portfolio management activity affects bond-fund returns, it is worth examining other measurements to understand the relative performance of municipals during 2015 without including the impact of professional management. One way to do this is by reviewing yield changes for maturities along the yield curve comparing U.S. Treasury securities to a representative muni-bond benchmark. Table 1 shows yield changes for 2015 for select Treasury issues, while Table 2 contains municipal-bond yield changes for comparable maturities.

 

Table 1. Yield Changes for Selected Maturity Categories of U.S. Treasuries during 2015

Table 2. Yield Changes for Selected Maturity Categories of Municipal Bonds during 2015

Source: Bloomberg (U.S. Treasury daily yield quotes) and Thomson Reuters Municipal Market Data (MMD; municipal yields on indicated maturities of ‘AAA’-rated issues based on proprietary data from MMD’s AAA Curve). Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results.
Past performance is no guarantee of future results. Performance during other time periods may differ. Due to market volatility, the market may not perform in a similar manner in the future.

 

In reviewing the data, it is clear that the performance was significantly different for most maturities.  Municipal bond yields decreased in the five-, 10-, and 30-year maturities, while Treasury rates rose. The two-year rates increased in both markets in response to U.S. Federal Reserve policy, but the municipal bond yield did not rise as much. These variations in yield changes across maturities and security types should be kept in mind the next time a financial news outlet reports movements in the 10-year Treasury rate as shorthand for the performance of all fixed-income markets. Similar to how equity sector performances fluctuate compared to the overall market, various bond markets can perform differently than Treasuries.

Muni Outperformance
The comparison between Treasuries and municipals focuses on the high-quality, interest rate-sensitive portion of the market. But what about other market segments? A common theme in the corporate bond market during 2015 was credit spread widening, as industries such as energy, and metals and mining, came under pressure. If the bond markets received media attention last year, it was for the potential credit issues in stressed sectors. Anyone following the headlines would have gained the impression that all credit markets were facing these issues.  In a similar vein, if there was any media attention on municipals, it primarily was focused upon the financial challenges of Puerto Rico and Chicago, which could have added to the impression that the larger municipal bond market was having credit issues similar to those of the taxable market.

Fortunately, that was not the case. Other than the handful of issuers in the headlines, municipal bonds fared well, outperforming corporates in both the investment-grade and high-yield segments, based on Barclays index data. This included all credit-rating categories within those segments, reflecting strong supply and demand characteristics of municipals, along with steady credit quality for the overall market.

Since it may have been difficult for investors to keep track of the differing performance indicators during the year, we’ll present two charts that outline the relative performance. Chart 1 is a comparison of movements in the ratio of municipal bond yields to corporate bond yields, based on the Barclays Municipal Bond Index and the Barclays U.S. Investment Grade Corporate Bond Index, respectively. Of course, there are variables other than pure yields causing some “noise” in these numbers, such as the greater likelihood that muni bonds would be callable, and a greater tendency for  municipal bonds to have longer maturities, but the trend is clear. Because the ratio of investment-grade municipal bond yields to corporate yields fell, municipal bond yields were decreasing compared to taxable yields. When yields decrease more, it leads to outperformance.

 

Chart 1. The Ratio of Muni Bond Yields to Corporate Yields Fell to Multiyear Lows in 2015
Municipal bond yields as a percentage of investment-grade corporate bond yields, December 23, 1999–December 23, 2015

Source: Barclays. Municipal bond yields represented by the Barclays Municipal Bond Index; corporate bond yields represented by the Barclays U.S. Investment Grade Corporate Bond Index. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
The historical data are for illustrative purposes only, do not represent the performance of any strategy managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results.
Past performance is no guarantee of future results. Performance during other time periods may differ. Due to market volatility, the market may not perform in a similar manner in the future.

 

Chart 2 depicts the high-yield portion of each market, as represented by the Barclays High Yield Municipal Bond Index and the Barclays U.S. Corporate High Yield Bond Index. The same trend exists. The ratio of high-yield municipal bond yields to those of high-yield corporate bonds has decreased, meaning that municipal bond yields in this rating category have decreased compared to those of taxable counterparts.

 

Chart 2. High-Yield Muni Bond Yields Fell Faster Than Those of Similarly Rated Corporates in 2015
High-yield municipal bond yields as a percentage of high-yield corporate bond yields, November 20, 2003–November 20, 2015

Source: Barclays. High-yield municipal bond yields represented by the Barclays High Yield Municipal Bond Index; high-yield corporate bond yields represented by the Barclays U.S. Corporate High Yield Bond Index. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
The historical data are for illustrative purposes only, do not represent the performance of any specific portfolio managed by Lord Abbett or any particular investment, and are not intended to predict or depict future results. Investors may experience different results.
Past performance is no guarantee of future results. Performance during other time periods may differ. Due to market volatility, the market may not perform in a similar manner in the future.

 

An analysis of municipal bonds compared to corporate bonds would conclude that municipal bonds did not have the credit spread widening that occurred in the taxable markets in 2015, and thus performed better. Similar to the comparison of municipals to Treasuries, it would be difficult for individual investors to gather this type of data based upon the daily information being provided by most media sources. Our investment team sees these movements throughout the trading day. Dealers are showing us the markets they are making on bonds, new issues they are bringing to the market, as well as bids and offerings being made by other investors. 

Over the past 15 years, the MSRB has done well in developing its website to provide regularly updated trade information, but investors most likely need more information to fully understand market performance. Within the municipal bond market, the constraint all we investors face is this: Of the $3.7 trillion in market value of bonds outstanding (according to U.S. Federal Reserve data), only a very small fraction trades daily. Another small fraction is offered, or has attracted bids, but does not trade. The vast majority of bonds in the muni market are held long term, predominantly by individuals, commercial banks, insurance companies, dealers, and mutual funds as a proxy for individuals. Many of these bonds will never trade after they are originally issued. In comparison with equities, there also is a lot of information that is necessary to be able to trade successfully, but throughout the day equity market indicators are available for many parts of the market and tickers of trading prices circulate across many sources. There can be wide bid ask spreads, but market makers create regular prices for most equities and investors can find data for most sectors and ranges of market capitalization.

Summing Up
Perhaps reflecting continued acknowledgement of the attractive environment for municipals during 2015, investor demand has continued to be strong into 2016. According to Lipper data, municipal bond mutual funds have seen positive fund flows for 18 consecutive weeks through February 4, 2016. Investors have been placing new assets in all ranges of maturities and credit quality, based upon their risk preferences. They may not be able to keep track of how their funds are performing throughout the day, but by tracking the movement in muni-bond fund net asset values, or comparing the tax-equivalent yields to other markets, they can understand the attractive relative value that munis offer. 

We won’t always have years like 2015 where municipal bonds outperform most other markets, but munis’ relative value has the potential to remain strong for some time. And while investors will rarely be able to gather updated information throughout the day from the typical media sources to enable them to follow the municipal bond market, investors can get a sense of the market’s performance by watching the factors we’ve discussed here.

One final thought: While it may be difficult for individuals to keep track of every development in the muni market, there are those people whose job it is to carefully watch the muni sector each day, and who really enjoy the challenges of understanding an inefficient market. Such observers appreciate the opportunity to use their collective experience and expertise to identify the most attractive investment opportunities along the way. These people are professional, active municipal bond portfolio managers.

 

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