1Q 2014 Munis: Value for Muni Investors
Themes in Municipal Bond Markets for 2014
JIM COLBY: This is one of those terrific times of year when strategists and portfolio managers get to make projections for the coming year. Important themes for muni investors to consider for 2014 are clearly tapering and the expectation of rising interest rates. What can an investor do with that information? Consider that although downgrades exceeded upgrades in 2013 by a small magnitude in terms of overall valuation, the marketplace for municipal bonds I believe is on the ascent. Rockefeller Institute's recent publication describes improvements in underlying economies. Hiring is increasing at the local municipal level, and it is expected that upgrades and downgrades issued by Moody's, S&P, and Fitch will probably level out with some equilibrium throughout 2014. That's quite a departure from the prior two years.
Important themes for municipal investors in 2014 are: being aware of the inherent stability in credit quality within municipal bond markets and realizing that tapering is on the table and interest rates are likely to rise. It's still possible to carefully positioning portfolios for these coming events.
Muni ETF Outflows in 2013 and 2014 Outlook
COLBY: In the calendar year 2013, especially for the seven months beginning in May of 2013, the municipal bond fund marketplace experienced redemptions. There were outflows to the magnitude of some $63 billion. Do we expect that to occur and continue in 2014? I think the answer is no. Reasonably, we don't expect that pattern to continue. We may have some residual outflows that continue to occur through the early months of 2014, but the reason for those outflows were based primarily on the expectation that tapering was going to force rates higher. The damage has been done. My opinion is that once investment advisors and investors take stock of the fact that rates are higher, opportunities are there for reentry, for repositioning cash that comes to portfolios by way of coupon payments, maturities, and bond costs. There are good reasons to find investment opportunities in the municipal marketplace. My expectation is that outflows will subside, the pressure on the secondary market will abate, and new issuance is not expected to overwhelm the marketplace. These factors bode pretty well for a decent second half of 2014.
Value for Muni Investors
Everybody wants to know where the value is. Where are the good opportunities for 2014? Coming off a tough performance year in 2013, it's a fair question. I would answer this way: there are ways to position oneself with fixed income in a broad asset allocation model to potentially generate important income for investment portfolios. Municipals in particular still offer a very compelling advantage on a taxable-equivalent basis compared to other asset classes. The real opportunity, I would say, is in the 10-year and shorter end of the yield curve. Why? Because you achieve less interest-rate sensitivity going forward in the long run. On a taxable equivalent basis, the reduced volatility and the superior returns relative to other asset classes, in my opinion, really merits attention.
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