The exodus of cash from municipal bond mutual funds has slowed down as the November spike in yields attracted buyers back into the market, following a few frightening weeks of outflows.
Municipal bond mutual funds that report their figures weekly posted a net outflow of $468.8 million during the week ended Dec. 1, according to Lipper FMI.
Though this was the third straight week of outflows, the seepage of cash from the $513 billion municipal fund industry decidedly slowed down following a turbulent couple of weeks last month.
November saw both the heaviest and the third-heaviest weekly outflows in history, with $3.1 billion and $2.3 billion withdrawn in consecutive weeks, based on Lipper data.
This was the heftiest withdrawal over any consecutive two-week period, by more than $1 billion.
Preliminary numbers from the Investment Company Institute paint an even more dire picture, with $7.6 billion withdrawn over a two-week period in the middle of November.
Lipper data shows municipal funds are coughing up $1.32 billion a week based on the four-week moving average, which is the highest since the throes of the financial crisis in 2008.
Outflows now appear to be easing.
“I don’t think we should read too much into the outflows,” said Ashton Goodfield, head of municipal bond trading at DWS Investments. “They seem to be moderating now and they could easily come back to positive.”
Last month’s outflows came at an inopportune time. The market was trying to digest nearly $11 billion in new issuance the second week of November, according to Bloomberg LP, and $14.8 billion the week after that.
A pivotal moment came on Nov. 11, when Standard & Poor’s downgraded $22 billion of tobacco bonds out of investment grade.
James Ahn, a portfolio manager with J.P. Morgan Funds, said the tobacco downgrade catalyzed a spasmodic domino effect across the municipal market.
With billions of dollars of tobacco securitizations knocked to junk, tax-free high-yield fund managers, who are big owners of tobacco bonds, began “looking to get ahead of potentially large outflows” from investors who wanted to stay in investment-grade products, according to Ahn.
Because tobacco bond prices were under pressure, he said these funds sold their highest-quality bonds first.
“All the severe selling began with the highest-quality holdings by these high-yield funds first, which resulted in broad price erosion,” Ahn said. “We saw them looking to build ample liquidity in preparation. Given the degree or the vigor of the outflows seen during prior periods of severe redemption activity, the high-yield fund managers were bracing for the worst.”
Thus, a downgrade of tobacco bonds bludgeoned the broader market.
Yields on long-term tax-free bonds spiraled up 37 basis points in two weeks, according to the Municipal Market Advisors scale, and several issuers shelved deals because the market turmoil made the economics unpalatable.
Muni mutual funds reported $14.1 billion in market losses during the two weeks ended Nov. 17 as tax-free bonds returned negative 3.8%, according to a Standard & Poor’s index.
The market began to calm down after Nov. 17, with yields pulling back in about 15 basis points.
Funds reported $978.4 million in market gains last week, according to Lipper.
“Pretty quickly, there was a bid in the market; there was a lot of interest in buying bonds,” said Dan Solender, director of municipal bond management at Lord Abbett. “When things appeared to stabilize, things bounced back pretty quickly.”
DWS’ Goodfield pointed out that certain deals people were worried about — such as California’s $1.13 billion general obligation sale or the $1.5 billion Illinois Railsplitter Tobacco Settlement Authority securitization — did well, drawing a lot of retail interest.
Municipal bonds have returned 1.4% since Nov. 17, which was the apex of mutual fund outflows and the near-term peak for yields on the 30-year MMA scale.
“The sell-off didn’t last that long,” Goodfield said. “I don’t think buying interest of munis has waned as much as mutual fund outflows might suggest.”
J.P. Morgan’s Ahn remains concerned that continuing stress on tobacco bonds could prompt high-yield managers to sell more of their high-quality holdings, rejuvenating the November domino effect, though likely to a lesser extent.
