The Irrational Fear of Muni Bonds

By Roberto Roffo, Senior Vice President/Portfolio Manager at Advisors Asset Management.

This year has been full of an exhausting parade of headlines related to defaults and potential defaults in the municipal market. While some of these headlines are warranted because of the size of the default, very few municipal bond managers were surprised by Detroit or the problems Puerto Rico is having.

The bigger surprise came as credit spreads widened to levels typically associated with defaulted bonds for an issuer that is still investment grade.  Fear mongering has played an important part in creating an environment of irrational fear among investors.

This irrational fear of municipal default has had investors running to the exits for most of the year as the market is witnessing historic outflows. The outflows have caused forced liquidations by managers at levels they might not have sold bonds at, which has led to municipal bonds trading at significantly cheaper levels relative to all other taxable fixed income asset classes. Municipal bonds have historically traded at 85% of U.S. Treasuries, due to the fear generated by the overabundance of headlines they have fluctuated at 100% of Treasuries.

When the numbers are looked at rationally and investors realize the risk associated with the municipal market, they will realize that all this negative news has created a massive buying opportunity, whether they believe rates are headed higher or not. The relative cheapness of municipals and the steepness of the yield curve can provide a cushion if rates do rise in the future. One thing to keep in mind is that the municipal market is not an easy place to navigate and a professional money manager is imperative in structuring a portfolio that will take full advantage of the cheapness of the market, and to monitor the credit of the portfolio in order to avoid the risks that do exist.

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The D2 Capital Management Tax Free Income Portfolio is currently yielding 4.7% (Tax Equivalent Yield at 28% Tax Bracket, of 24 December 2013).

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.