What Happened to the Muni Market Timers of March? | Lord Abbett
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Fixed-Income Insights

Here’s a look at how the municipal bond market functioned during and after the March volatility—and the experience of the investors who chose to sell at its height.

Read time: 5 minutes

When any market goes through a period of volatility, some investors change their long-term investment strategy by selling holdings in their portfolio. Sometimes these calls make sense, but often it is tough to time the decision successfully, and the ensuing transaction costs make the trade less economical.

That can be true of municipal bonds, where it is often costly to sell a bond during a down market.  Also, upward and downward movements in prices in muni bonds can be exaggerated because approximately two-thirds of bondholders are retail investors. Individuals may be quicker to unload muni bonds in response to negative headlines about the market than institutional investors such as pension funds that are focused on meeting future liabilities through holding long-term investments.

This March, we had one of those big down markets we get every few years, albeit with greater volatility than previous episodes. We think it is worth examining how the market was functioning during the tough times and how it has performed since then.

The municipal bond market typically trades at yields which are lower than comparably rated taxable fixed income markets because the income from munis is tax exempt.  For example, the benchmark for AAA-rated 10-year municipal bonds is historically around 80% to 85% of 10-year Treasury bonds. Similarly, bonds with more credit risk such as BBB-rated or high yield bonds trade at yields which are lower than comparably rated corporate bonds.  When we go through short-lived periods of market stress like we saw in March–when municipal bond mutual funds experienced almost $30 billion of outflows1 during a three-week stretch–all those relationships changed.

Why? When investors flock to the perceived safety of U.S. government debt, yields on Treasuries move lower. Meanwhile, municipal yields rise because of (1) greater concern about issuer credit and (2) muni yields need to reach levels that will attract buyers who are choosing between markets to raise the liquidity they need. Traditional municipal bond buyers are responding to outflows so they have limited capacity to buy more bonds; banks, because of regulatory changes to the amount of bonds they may hold, are no longer a source of liquidity to the muni market.

Heading for the Exits

Back in March, the municipal market got stressed due to all the selling pressure. One way to see this is through the daily trading flow statistics as they are reported to the Municipal Securities Rulemaking Board (MSRB). According to data from Bloomberg, MSRB’s reported trading volume hit its highest levels around March 19-24. (See Figure 1.) During the peak days the volume of trades was over $30 billion, which is about three times the typical amount. 

 

Figure 1. Muni Bond Trading Volume Has Moderated after March Spike
Dollar volume of municipal bond market trades, March 19, 2020–June 13, 2020

Source: Municipal Securities Rulemaking Board and Bloomberg. Data as of June 14, 2020. Average volume at trade is on a rolling three-month basis.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Another way to measure the market stress is to look at the amount of bonds put up for sale. The most common way to sell is to put bonds out for bid on the Bloomberg system; sure enough, the days with the most selling pressure also had the biggest amounts of bonds for sale (see Figure 2).

 

Figure 2. Sellers Flooded the Municipal Bond Market During the March Volatility
Dollar volume of municipal bonds out for bid on Bloomberg system, June 18, 2019–June 18, 2020

Source: Bloomberg. Data as of June 18, 2020.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Over the past year, the average amount of bonds out for bid on a typical day has been $778 million. On the busiest days in March, there was more than $4 billion for sale. When this imbalance exists, prices move down quickly because yields must move up to find buyers. This gets back to the point we made earlier about making sudden portfolio changes. These were the days when the largest number of investors decided to sell municipals to move into cash or another asset class even though the liquidity cost was the highest at that time.  To be fair, some were potentially selling munis to meet margin calls; but still they likely had a choice of assets to sell, and they chose municipals.  As can also be seen in these charts, trading volumes and bonds out for bid have normalized and market has been functioning well since the brief disturbance.

So how did it work out for those who chose to sell during the height of the March volatility? From the vantage point of late June, it is clear to us that these decisions did not work out well based on performance.  To be fair, if an investor has a firm belief that the market will get worse over the coming year, they likely will maintain that it is too early to judge that decision.  Still we think it is important to determine the current impact of certain muni investors’ rush to the exits in March—and consider what types of returns will be necessary to make up for their market timing decisions.

Missing the Recovery

As with many forays into market timing, the results have not been favorable. The muni market has staged a broad recovery since March, with all maturities performing well, though the pace of the rally has moderated in recent weeks.  As of June 18, the Bloomberg Barclays Municipal Bond Index (muni index) has a three-month total return of 4.61%.2 As for the maturity-specific subindexes of the muni index, the long bond index (maturities 22 years and longer) is up 4.86%.  The seven-year index is up the most at 5.42% while the 10-year index is next at 5.10%.

How about the lower quality portion of the market? The rebound has been slower due to uncertainty about the economy and future government support for muni issuers, but it is coming on strong.  The A-rated index is up 4%, not far removed from the AAA and AA indexes, which are up more than 5%.3 The BBB-rated index is up 1.42% and the Bloomberg Barclays High Yield Municipal Bond Index is up 5.34%.  The latter index has rallied 3.33% during the first 18 days of June so it has come on strong recently, though it should be noted that some large issues, such as tobacco settlement bonds, can have a significant impact on the performance of the index, so it is fair to say that a lot of high yield bonds have not moved as much.  The main point is that broadly speaking, investors have seen solid returns at all portions of the credit and maturity spectrum since the worst days in March. A spur-of-the-moment decision to sell at the height of the March volatility means that investors would have missed out on this recovery.

How does market timing look under in the context of year-to-date returns?  Despite the recent recovery, the high yield muni index is down 3.23% year-to-date.  Investors who sold high yield muni funds in March likely would have very negative returns, while those who held on are now moving closer to unchanged.  Even more striking, after all the volatility in March, the high yield index still had a positive 12-month return of 0.64%. Factor in munis’ tax-exempt status, and the tax-equivalent return would be roughly comparable to some other fixed income investments.

On the investment grade side, the muni index has had a 1.84% return year-to-date. Despite the tough March, investors who held on have attained the positive returns they were hoping for with an historically low credit-risk investment. All maturities are positive as of this writing with the best return coming from the 10-year index at 2.26%. For the one-year period, the index has a 4.41% return. The best performing maturity index over the year is the 15-year at 5.05%, with the 22+ year close behind at 4.99%.

It is also important to remember that those who chose to exit the market during the March selling may have suffered a double whammy—declining prices for municipal securities and the elevated liquidity costs associated with market volatility, especially for individuals executing odd-lot trades. Thus, the returns for people selling out of individual bonds at that time may be much worse than the fund-level data.

Summing Up

Investors should always be mindful of their asset allocations, but they also need to think carefully about trades they are making in volatile markets. As many learned during the past few months, short-term investment calls are hard to make.  Often short term performance is influenced by transitory factors like the March liquidity event rather than the things that help determine long-term performance: credit conditions, inflation, economic growth, and other macro-level influences. As recent events have shown, investors who maintain that long-term focus during periods of volatility may find themselves in a far better position over the long haul than those who try to time the market.

 

1Mutual fund flow data from Lipper.

2All year to date performance numbers cited are through June 18, 2020.

3AAA, AA, A, and BBB indexes are rating-specific subsets of the Bloomberg Barclays Municipal Bond Index.

 

A Note about Risk: The value of an investment in fixed-income securities will change as interest rates fluctuate and in response to market movements. As interest rates fall, the prices of debt securities tend to rise. As rates rise, prices tend to fall. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. High-yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Lower-rated investments may be subject to greater price volatility than higher-rated investments. A portion of the income derived from a municipal bond may be subject to the alternative minimum tax. Any capital gains realized may be subject to taxation. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Investments in Puerto Rico and other territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems.

The information provided is for general informational purposes only. References to any specific securities, sectors or investment themes are for illustrative purposes only and should not be considered an individualized recommendation or personalized investment advice, and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. Past performance is not a reliable indicator of future results.

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The tax-equivalent yield is the pretax yield that a taxable bond needs to possess for its yield to be equal to that of the tax-exempt yield on a municipal bond. This calculation can be used to fairly compare the yield of a tax-free bond to that of a taxable bond to see which bond has a higher applicable yield. The tax-equivalent return on a municipal bond reflects the tax-equivalent yield and price changes on the underlying securities.

The Thomson Reuters Municipal Market Data (MMD) AAA Curve is a proprietary yield curve that provides the offer-side of “AAA” rated state general obligation bonds, as determined by the MMD analyst team. The “AAA” scale (MMD Scale), is published by Municipal Market Data every day at 3:00 p.m. Eastern standard time, with earlier indications of market movement provided throughout the trading day. The MMD AAA curve represents the MMD analyst team’s opinion of AAA valuation, based on institutional block size ($2 million+) market activity in both the primary and secondary municipal bond market. In the interest of transparency, MMD publishes extensive yield curve assumptions relating to various structural criteria which are used in filtering market information for the purpose of benchmark yield curve creation.

The Bloomberg Barclays Municipal Bond Index a rules-based, market-value-weighted index engineered for the long-term tax-exempt bond market.  Bonds must be rated investment-grade (Baa3/BBB- or higher) by at least two ratings agencies.

The Bloomberg Barclays High Yield Municipal Bond Index is an unmanaged index consisting of noninvestment-grade, unrated or below Ba1 bonds.

Bloomberg Barclays Index Information:

Source: Bloomberg Index Services Limited. BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices. Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. 

The credit quality of the securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer's ability to pay interest and principal on these securities.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education.  None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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