FA Magazine March 2023 | Page 49

clients start seeing red on their statements and start pulling money ,” she says .
The selloff was entirely related to the Fed ’ s interest rate hikes , she says , and had nothing to do with credit quality , which is very high . When outflows like that occur , municipal bond yields have to become more and more enticing to attract buyers , which results in some very good news for investors .
“ They start getting very attractive relative to Treasury yields ,” she says . “ All of a sudden that muni-to-Treasury ratio starts getting extremely cheap , and you start looking at 10-year tax-free yields at 3.75 %, the taxable equivalent of about 6 %, which is pretty juicy , and you start to have money coming back in .”
That tax-free status not only resonates strongly with high-net-worth clients , it also translates through time to much bigger gains beyond the immediate yield . income taxes , payroll taxes ; all are near record-level highs .”
Even if the U . S . slips into recession this year , it would take some time before a drop in tax revenue elevates municipal bond credit risk . “ Oftentimes , taxes are based off lagging numbers ,” Cooper says . “ It takes about three years before a change in market value actually translates into a change in property tax levels for local governments . That long runway gives state and local governments pretty ample planning time to make adjustments if they need to .”
In addition , municipalities tend to have very few credit downgrades because revenue sources are so stable , he says . Patel adds , “ Multiple rounds of federal fiscal stimulus during the pandemic and the result of revenues exceeding forecasts have brought about a situation where most states and most issuers are
Even if the U . S . slips into recession this year , it would take some time before a drop in tax revenue elevates municipal bond credit risk . but for munis specifically we saw rates move up anywhere from 150 to 200 basis points across the curve ,” says Nisha Patel , a managing director at Parametric in New York in charge of portfolio construction and risk management for the tax-advantaged bond strategies group .
The Fed ’ s aggressive interest rate policy and the associated bump for U . S . Treasury rates has a trickle-down effect for municipal bonds , albeit with a bit of a lag . But the current buoyancy in the muni market has only partly to do with that , she says . A selloff in munis earlier last year was hard to watch , but it paved the way for some of the gains now .
“ Last year , almost $ 120 billion was pulled out of muni mutual funds , which is a lot . I think about 4 % to 5 % of the entire market . It ’ s a phenomenon that occurs in a retail-dominated market where
“ The most important point about municipal bonds is that they ’ re tax-free and compounded , and if it ’ s reinvested over and over , that ’ s great for the client ,” says Michael Pidhirskyj , a CFA and director of fixed income at Pitcairn in Jenkintown , Pa . “ Those end up being huge gains .”
Outstanding Credit Quality
Thanks to the federal aid throughout the Covid crisis and an anticipated pandemic downturn that proved shortlived , municipalities are in great fiscal shape , sources say .
“ State and local government revenues are up quite substantially ,” says Cooper Howard , director and fixed-income strategist for the Schwab Center for Financial Research . “ They ’ re at record highs if you look at things like corporate income taxes , property taxes , individual two to three times better off from a liquidity standpoint going into this recession than they were going into 2008 .
“ In short ,” she adds , “ credit fundamentals in our view have never looked stronger .”
Some Commitment , But Not Too Much
Because of where yields lie right now , there ’ s no need to stay short with munis , but no need to go super-long , either , sources say .
Patel says she ’ s recommending a oneto 15-year ladder , and even “ chopping off the first few years ” would be fine . “ We like the idea of adding duration in the context of it being a good way to lock in yields for an extended period of time . If yields fall , having duration will help from a performance standpoint ,” she says .
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