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Strategy & Commitment - Friday, 05/11/2012

Municipal yield curve steepness was a significant contributor to 2011 municipal bond returns, and it currently remains so. Because recent changes in yields have been fairly consistent across maturities, the intermediate part of the curve (10 to 14 years) — where yield differences of as much as 25 basis points currently exist between each maturity — continues to be a focal point. Thus, investors should consider how best to assess the combined risks associated with credit and maturity.

Municipal Market Advisors (MMA) recently noted that YTD returns from bonds with a duration of 10 years and shorter had provided less than 15% of all municipal bond market returns, while those with a duration of 20 years and longer had generated 25%. This seems logical to me given that, in my opinion, the Federal Reserve is likely to continue to hold short-term rates at low levels as long as inflation is contained. Investors must consider that the risk measured by the difference in duration of intermediate versus longer-term bonds exposes them to potential price declines exceeding 50% when rates rise. That risk drops to 29% with intermediates.1 The ability to swiftly adjust strategy when market conditions change is also important.

The market has demanded yield. High-yield muni mutual funds and ETFs have continued to see inflows, pushing prices higher. Evidence suggests that muni bond investors are using strategies that encompass a combination of intermediate to long duration and high yield to accomplish their goals in today's market.

 

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As of 5/10/12. The difference in interest rate risk, as measured by modified adjusted duration, between intermediate and long (Barclays Capital 10-Year Municipal Index and Barclays Capital 20-Year Municipal Index) is 5.89 versus 9.66 = 64% greater interest rate sensitivity. Modified Adjusted duration calculated by Barclays Capital. 

 

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Please note that MUNI NATIONs written by Jim Colby represent his opinions and these opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Global. © 2014 Van Eck Securities Corporation. MUNI NATION is a trademark of Van Eck Associates Corporation.

All indices listed are unmanaged indices and do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

Any discussion of specific securities mentioned in the commentary is neither an offer to sell nor a solicitation to buy these securities.

Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer’s financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Bonds and bond funds will decrease in value as interest rates rise. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. Municipal bonds may be less liquid than taxable bonds.

The income generated from some types of municipal bonds may be subject to state and local taxes as well as to federal taxes on capital gains and may also be subject to alternative minimum tax.

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