Even during the toughest of times, people still drink water and go to the bathroom.
That is the logic underpinning Dick Berry's affinity for municipal bonds secured by revenues from essential services like water and sewage treatment.
The 64-year-old Dallas native, who manages muni portfolios at Invesco AIM, likes water and sewer bonds because they provide dependable cash flow for bondholders even in a recession.
"These are services that are not interrupted, even during economic downturns," said Berry, who began working at Invesco in 1987. "If you have a house, you have to be connected to the sewer. It's not elective."
These kinds of bonds are typically issued to build or improve a public utility that oversees water and sewer services for a certain district.
The coupons and principal on the bonds are repaid using the fees the utility charges residents in the district for the services.
While Berry said he is not permitted to discuss specific bonds or credits, two of the biggest issuers in this sector are the Metropolitan Water District of Southern California and the Massachusetts Water Resources Authority, with outstanding revenue bonds of $4.23 billion and $5.5 billion, respectively.
Berry said he usually values bonds in this sector using what he calls a "rich-cheap" analysis. That entails comparing the yield on a revenue bond to the yield on a similarly rated general obligation bond, and relating that yield to a historical average.
He is trying to snap up essential service revenue bonds that are cheap compared with GOs relative to their historical averages.
Tumbling property values and shrinking tax receipts lead him to be cautious of GOs. He anticipates resistance to higher taxes making it tougher for state and local governments to repay their debts.
"Even though the textbooks will tell you they're superior quality, in reality they're not," he said.
Plus, the sector offers big spreads over GOs for investors willing to step down the credit ladder a bit, he said.
He is buying single-A and Baa-rated revenue bonds, if he likes the credit quality.
That is an important qualifier: the sector is not monolithic. Like any kind of company, some water utilities are well-run and others are not, Berry said.
Investors have to look at a utility's balance sheet and examine its cash on hand and past-due receivables from customers, he said.
Another important metric is debt-service coverage, which measures how comfortably a utility can repay its debt using income generated from its services.
Berry manages two muni funds with combined assets of about $847 million for Invesco.
Berry points to an American Society of Civil Engineers report last month giving the nation's infrastructure a grade of "D." The group said the country needs to spend $2.2 trillion on infrastructure in the next five years just to become adequate.
Much of this spending will be financed in the muni market, Berry said.
He is not worried about what all the new supply will do to prices on existing essential service revenue bonds. With the baby boomers retiring and looking for reliable income, Berry thinks the demand will be there.
"The demand's pretty good right now," he said. "I think we'll have pretty steady demand that will easily absorb all these new issues."
If anything, Berry would like to see more water and sewer bonds available for sale.
"We're kind of at the mercy of what the market is offering," he said. "It's supply-dominated, and whatever's being offered for sale is what we have to look at."
