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Market View

Accessing the potential investment opportunity offered by the municipal bond market requires several levels of expertise that few individual investors have.

Many investors are taking a fresh look at municipal bonds, especially in light of their ability to provide tax-free income. In this Market View, we offer five reasons why individual investors may want to consider the guidance of a professional muni bond manager, as they seek to invest in this vital marketplace.

Reason 1: Access to a Broader Pool of Bonds Widens the Opportunity Set


Chart 1. Dealers’ Inventory Levels Have Shrunk 60% Since 2006
Dollar amount of muni bonds on dealers’ books, (2006-2018)

Source: The Bond Buyer. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.


Municipal security trades occur via the over-the-counter market, rather than on a centralized exchange. This means investors looking to buy or sell bonds must go through dealers. For an individual retail investor to shop around for competitive prices, he or she would need to do so through multiple dealers, which would require multiple brokerage accounts. Making it even more challenging, inventory levels across dealers have shrunk dramatically. Since 2006, the dollar amount of muni bonds on dealers’ books has declined by approximately 60%, making it more difficult for financial advisors to find attractive bonds for their clients.

Reason 2: Institutional Pricing Benefits May Lead to Lower Transaction Costs


Chart 2. Buying Bonds in Bulk May Reduce Bid-Ask Spreads
Bid-ask spreads of municipal bond trades,* par value 

Source: Report on Secondary Market Trading in the Municipal Securities Market, MSRB, July 2014.  Data are the most recent available.  For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.


Portfolios managed by institutions can stand to benefit from the pricing advantage associated with purchasing large blocks of bonds as opposed to smaller sized trades. According to the Municipal Securities Rule Making Board (MSRB), buying bonds in bulk may reduce bid-ask spreads, lowering transaction costs, and ultimately boosting yields for investors. In fact, the MSRB report showed that, on average, trades less than or equal to $25,000 came with a bid-ask spread of 233 basis points (bps), while those greater than $5 million came with a spread of only 13 bps.

Reason 3: Credit Research May Mitigate Downgrade, Default, and/or Price Risk

Before the 2008 credit crisis, some municipal bond issuers were able to reap the benefits of lower borrowing costs by paying for insurance on their debt, thereby guaranteeing principal and interest payments owed to investors. According to Bloomberg Barclays,1 post-crisis and after the fall of most bond insurers, the percentage of ‘AAA’- rated municipal bonds fell from roughly 70% in 2007 to roughly 15% by the end of 2018. What’s more, less than 10% of newly issued municipal bonds outstanding carry insurance. With this in mind, employing a team of dedicated investment professionals who perform in-depth credit research and monitoring on each security purchased is necessary. The information necessary to conduct detailed credit research is typically unavailable in mainstream financial publications, and thus professional managers have access to resources (and time) that most individual investors do not. While many investors think “state and local governments” when it comes to municipal bonds, roughly two thirds of the market is comprised of revenue bond, not general obligation, issuers.

Reason 4: Multiple Forms of Relative Value Assessments May Be a Tailwind To Returns


Chart 3. Muni Managers Conduct Relative Value Assessments to Optimize Potential Returns
Case Study: Expected total returns per maturity

Source: Municipal Market Data. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.


The benefits of hiring a team of investment professionals extend far beyond the need for credit research and include relative value assessments. In a roughly $3.8 trillion market (according to Reuters), there are many decisions that must be made in order to optimize potential risk-adjusted returns. For example, within a portfolio of municipal bonds, which sectors should be underweight and which should be overweight relative to market? Within each sector, which issuers should be focused on? Unlike the equity market, the fixed income market offers several options per issuer. For example, while a company has one common stock, it may have a number of different bond issues trading in the secondary market that will vary based on maturity, coupon, duration and other characteristics. Are credit rating agencies late to upgrade a specific issuer? If so, is the upgrade priced in or does an opportunity exist?

We believe a maturity decision, or yield curve positioning, is an important element of consideration that involves an evaluation of the current shape of the muni yield curve and potential yield curve shifts. Some portfolio managers seeking the optimal total return profile look to purchase bonds on steep portions of the curve that, although they may not offer the highest yield relative to similar bonds, may offer the highest expected return based on how the price may be expected to change as time passes and the bond “rolls” down the curve.  

Reason 5: Investment Professionals View Returns On a Risk-Adjusted Basis

We believe risk management is essential in all investment processes, and municipals are no different. While return and yield on an absolute level are often the focal point of retail investors, investment professionals view return and yield on a risk-adjusted basis, considering reward in the context of risks taken. Additionally, while risks may be taken to achieve rewards, professional managers seek to mitigate risks in several ways.

Much of what we have discussed so far is associated with risk management, including in-depth credit research and monitoring to lower credit risk, relative value assessments to reduce valuation risks, and a wider access to bonds to mitigate opportunity risk. Additionally, relative sector/position limits and diversification offer the potential to decrease portfolio volatility that stems from being overly concentrated in any one sector or issuer. Risk management systems may be used to analyze municipal bond portfolios based upon a large number of attributes, including yield-curve positioning, duration characteristics, credit-quality weightings, sector weightings and coupon weightings and to quantify relative exposures by sector, subsector, and issuer, as well as interest-rate sensitivity and volatility.

Summing Up: The Potential Advantages of Active Management

Individual investors needn’t be intimidated by the complexity of the municipal bond market. A professional municipal bond manager can provide the broad access to the marketplace, pricing power, credit expertise, relative value perspectives, and risk management capability that most individual investors do not have.


1The statistics are using the credit quality breakdown of the Bloomberg Barclays Municipal Bond Index as of December 31, 2018. The Bloomberg Barclays Municipal Bond Index is 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. Indexes are unmanaged, do not reflect the deduction of fees and expenses, and are not available for investment.



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.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.

References to specific securities and issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in portfolios managed by Lord Abbett and, if such securities are held, no representation is being made that such securities will continue to be held. 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.

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. Investments in Puerto Rico and other U.S. 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.

Glossary of Terms

The bid-ask spread is essentially the difference between the highest price that a buyer is willing to pay for an asset and the lowest price that a seller is willing to accept.

Duration is an approximate measure of a bond's price sensitivity to changes in interest rates.

general obligation (GO) bond is a municipal bond backed by the credit and taxing power of the issuing jurisdiction rather than the revenue from a given project. 

 A revenue bond is a municipal bond supported by the revenue from a specific project, such as a toll bridge, highway or local stadium.

yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates. 

The credit quality of the securities in a portfolio are 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.

No investing strategy can overcome all market volatility or guarantee future results. 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.

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 this commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.


  Market View



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