A recap of the year just concluded and a look ahead to the next 12 months is an annual big-picture exercise that investors have come to expect from professional asset managers.
As a boutique municipal bond portfolio manager working with high-net-worth investors, their advisors and family offices, we believe that the “small picture” warrants attention as well.
The “big picture” in the muni market entails consideration of interest rates, the macroeconomic climate and the financial health of municipalities generally. Throughout my municipal bond career, first at Merrill Lynch and now at Riverbend Capital, I’ve observed that, while the macro picture and the economy certainly affect the muni market, wagering on the direction of interest rates and making investment decisions based on those bets often does not end well.
There is value to be captured on behalf of investors, however, by a manager carefully scrutinizing the creditworthiness of specific issuers and by being an active and knowledgeable participant in the less-than-transparent market for municipal bonds. You might call that the “small picture,” but I believe it’s where a lot of the real benefits of municipal bond investing are to be found.
For investors like our clients, the objectives of an allocation to municipal bonds include safety of principal, predictable income generation and attractive after-tax yields. As a bespoke manager, Riverbend provides services that can help municipal bond investors even during times of stress — like 2022. At its lowest point in October, the municipal market as measured by broad market indexes was down about 13%, which was its worst performance in decades. We’ve managed through these challenges, in some cases realizing losses to offset gains elsewhere in portfolios. In other situations, we were able to buy high quality replacements at distressed-sale prices — which highlights another “small picture” benefit.
Being nimble in that way can be more difficult for municipal bond mutual fund complexes. Unless they keep large reserves of cash on hand, which reduces fund performance, fund managers must sell holdings to meet redemptions. During most of 2022, there were huge outflows from municipal bond funds as their shareholders threw in the towel. That meant managers had to sell bonds to meet redemptions, which drove prices even lower. At times when market liquidity was strained, attractive bonds were sold first in order to raise cash most quickly.
During periods of extreme market sentiment, as experienced in 2022, volatility causes price distortion, which created unusual opportunities for long-term investors and for “small picture” players to come in and snap up bargains when sellers are extremely eager to find buyers. As in 2022, this provides opportunities to buy high-quality bonds at what could be considered discount prices.
While we are wary of making big picture pronouncements for 2023, it seems as if the modest recovery that began in October may continue. In the meantime, we’re finding opportunities to buy high quality municipal bonds with attractive taxable equivalent yields. That’s a small picture perspective that muni bond investors may appreciate.