Muni Supply-Demand Forces Awaken in 2018
Michael Cohick: So far this year, most fixed income investments have struggled to offer investors positive performance. However, the municipal asset class has been one of the bright spots, and high yield munis in particular have been notable. Based on recent flow data, it appears investors are once again taking note of this important diversifying asset class. I'm Michael Cohick, Director of ETF Product Marketing and Senior Product Manager at VanEck and I'm joined today by Jim Colby, a Municipal Portfolio Manager and Senior Municipal Strategist. Jim, thanks for joining us.
Jim Colby: Thanks, Mike, let's get to it.
Cohick: Let's get to it. So give us your macro recap, what have you been keeping your eyes on so far this year?
Colby: Well, Mike, here's what you need to know: the municipal market operates on a model of supply and demand. And issuance of new municipal bonds year-to-date is down some 15-20% from a year ago. Demand, the other side of the equation, has been pretty constant. And in fact, the months of May and June are months to consider for reinvestment in the municipal space because of bonds that mature, bonds that pay coupons, and bonds that get called. The other features of the marketplace that you need to know about is controlled really by the Federal Reserve. The action the Federal Reserve has taken so far this year and what they propose to do with raising rates through the balance of this year - maybe two, three more times - has put pressure on investment grade and put pressure on the municipal yield curve. In fact the curve has flattened, which has caused a little bit of concern by investors, preferring to mitigate their risk by moving further down the curve, reducing duration risk. The other thing that has occurred was the passage of the Tax Act at the end of 2017, which in fact caused banks and insurance company portfolios to sell bonds and sell investment grade bonds in the intermediate part of the curve, which has also contributed to underperformance.
Cohick: Needless to say, a lot going on. Are there other market dynamics that might be positive or negative for the asset class?
Colby: Well, in high yield especially, there's one particular feature that is worth paying attention to, that probably will be pervasive through the rest of 2018, and that is refinancing's that have occurred in the tobacco securitization sector. Already we've seen some $3 billion of tobacco bonds taken out of the high yield portfolios by a refinancing, which has had the impact of raising the prices of the remaining securities in the high yield space, which actually accounts for the strong performance in high yield on a relative basis.
Cohick: And finally, Jim, where do you see the greatest potential opportunity as we go into the rest of 2018?
Colby: Well, I think it's going to continue to be high yield. We already are seeing the evidence of yet another big tobacco refinancing occurring. I don't see the new issue calendar providing much in the way of new bonds for not just our ETF high yield product, but other high yield portfolios in this space, looking forward to supplement those bonds that have been removed. I think that price performance is going to augur well. It will also support those who are still a little bit risk-averse, because of the continuing rise in interest rates, moving down the curve perhaps, selecting a shorter duration high yield product that has the potential also to perform pretty well.
Cohick: Like in previous years, that supply-demand imbalance is rearing its head again?
Colby: Well, I think that's going to be the theme for 2018.
Cohick: Excellent. Thanks, Jim, for your insight.
Colby: Appreciate it.
Cohick: VanEck offers a variety of municipal bond ETFs, three based on the segmentation of the investment grade yield curve as well as three based on credit quality.
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