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Firms Hike Their Muni Holdings

APR 9, 2010 8:01pm ET
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Many of the biggest institutions that own municipal bonds beefed up their holdings last year as state and local government debt became something of a preferred asset.

The 100 Largest Institutional Holders of Municipal Bonds
The 500 Largest Municipal Portfolios at U.S. Banks

Vanguard Group, Franklin Templeton Investments, and Nuveen Asset Management — the three biggest institutional holders of municipals according to Thomson Reuters eMAXX — all added healthily to their stocks of muni bonds.

The three cater heavily to retail investors through products like mutual funds, closed-end funds, money market funds, and separately managed accounts.

Vanguard Group overtook Franklin Templeton for the number one spot among institutional holders, boosting its holdings by 28.2%, to $79.8 billion.

Vanguard runs 13 municipal bond mutual funds, plus six tax-free money market funds and a variety of retirement funds and other accounts.

Franklin Templeton slipped to number two, with a 13% increase to $70.4 billion. The firm runs dozens of mutual funds, including state-specific funds, and a handful of money market funds.

Nuveen leapfrogged American International Group to claim the third spot after an 8.7% bulk-up in holdings, to $53.7 billion.

Chicago-based Nuveen is the undisputed leader in municipal closed-end funds, with nearly half the industry's assets. Nuveen runs more than 100 closed-end municipal funds with $34.9 billion in assets. The company's municipal bond mutual funds also grew to $16.14 billion.

Institutional ownership of munis grew last year for a number of reasons, not the least of which is that the municipal market overall grew.

According to the Federal Reserve, municipal securities outstanding expanded 4.8% to $2.812 trillion, as state and local governments floated about $415 billion in new bonds.

Sheila Amoroso, co-director of the municipal bond department at Franklin Templeton, said retail investors adopted a more favorable attitude toward munis in the wake of the credit crisis.

When everything except Treasury bonds was clobbered in the fourth quarter of 2008, Amoroso said, debt from municipalities exhibited less volatility than stocks, corporate bonds, or other investments.

As investors reconsidered their mix of investments, municipals were seen as a safer and more stable asset, she said.

Demographics have also played a role, she said. Baby Boomers are approaching retirement and as a result, a higher percentage of the population is looking for conservative, income-producing investments suitable for retirement.

Then of course there is the matter of taxes.

"Has the relative attractiveness of munis appealed to more investors? The potential relative attractiveness of munis down the road? I'd have to say yes," Amoroso said. "We know we're heading into higher tax rates. We know there's going be some type of surcharge on taxable income that is not going to be on tax-exempt income that will further increase the appeal of investing in tax-free funds."

Craig Brandon, who manages more than a dozen municipal funds at Eaton Vance, pointed out that when more than half of all new municipal bonds came to market with an insurance wrap, retail investors had less need to entrust their money to an institution.

Municipal bonds traded like commodities, he said, so why pay Eaton Vance to pick your bonds for you?

After the bond insurance industry imploded and the financial crisis sent municipal debt into a tailspin, retail investors felt more comfortable letting institutions conduct the credit research and bond selection for them, he said.

"People are comfortable having somebody who's been in the municipal market for decades and is familiar with all the credits do the credit work for them," he said. "There's a lot to be afraid of out there and I think they want to rely on someone to understand what the real problems are."

Whatever the reasons, many of the institutional products geared toward retail investors accumulated a lot of cash last year.

According to the Investment Company Institute, municipal bond mutual funds commanded $69 billion in new money from investors in 2009. The muni closed-end fund industry grew by more than $12 billion, to nearly $80 billion. And exchange-traded funds began making a bigger splash, more than doubling in assets to $6 billion.

Nothing in 2009 did more to influence the complexion of municipal bondholders than the creation of the Build America Bond program.

Enacted under the federal stimulus legislation last year, the BAB program enables issuers to float taxable bonds.

The program has been a smash. According to Thomson Reuters, issuers have sold $91.7 billion in BABs since the program's inception last April.

Nearly a third of municipal debt issued in the first quarter of this year was taxable, according to Thomson Reuters.

Brandon, who runs Eaton Vance's BABs fund, said taxable municipal bonds appeal to a number of types of investors who have long been interested in state and local government debt but had no reason to buy it because the tax exemption kept yields too low.

Taxable municipal bonds open the market to pension funds, 401(k) accounts, and foreign investors, Brandon said.

The newfound foreign interest in U.S. state and local government credit further highlights the role institutions play in managing municipals for clients, Brandon said.

An investor in Hong Kong or Switzerland may never have heard of the New Jersey Turnpike Authority or the Los Angeles Unified School District, so he is more likely to trust an institution to sort out municipal credits, Brandon said.

"I think that a lot of the international investors want to buy the investment through a U.S.-based firm that has some research capabilities," Brandon said. "A lot of the international purchasers are doing it through somebody in the U.S."

Foreign investors owned more than $60 billion in municipals at the end of 2009, according to the Fed, their biggest-ever share of the market.

Also in the top 10 among institutional holders were insurance companies AIG, State Farm, Travelers, and Allstate. AIG's municipal holdings slipped nearly 24% to $43.9 billion. The beleaguered insurer's entire portfolio of municipal bonds is for sale.

Allstate is also selectively paring its municipal portfolio, which shrank 8.4% to $22.7 billion. Executives of the Northbrook, Ill.-based company have said they were trimming exposure because of concerns about municipal credit quality.

The 100 biggest institutional holders own $930.8 billion, about a third of the market. Data from Highline Financial show the 500 biggest bank portfolios total $158.71 billion in municipals, an increase of 7.7% from 2008 fueled mainly by market gains. On a cost basis, holdings increased 1.7%.

Many of the biggest banks including Citi, Wachovia, and Bank of America shed their holdings. JPMorgan was the most active buyer among banks, adding $2.6 billion to its stockpile, which now totals $3.5 billion.

Citi remains the biggest holder among banks, with $14.15 billion, down 10.9% from the previous year.

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