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Investing Strategies Emerge As Industry Emerges from Rocky Strait

NOV 15, 2012 4:51pm ET
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The municipal market has seen falling yields, lighter supply and tightening credit spreads of late.
It has also had to endure a devastating hurricane, the U.S. elections, and all of the attendant uncertainty they brought. And finally it has had to contend with shorter weeks of fewer trading sessions.

Amid these, technicals remain sound and demand particularly strong. And there are plenty of opportunities in the market for investors, industry watchers say. But they are varied.

For some, muni strategies point toward capital preservation through duration-neutral approaches. Others see safety in the intermediate part of the yield curve.

And still others like single-As and the structures on offer at the long end of the curve. Looking well into 2013, one industry watcher likes the potential for total return in high grades at the long end of the curve.

Portfolios remain duration-neutral at DWS Investments, said Phil Condon, a chief investment strategist for fixed income and lead muni portfolio manager there. He doesn’t see much value in low investment-grade munis and high-yield at the moment.

High-yield munis have tight credit spreads and very long durations, he said. Thus, he added, there’s a mismatch there: yields look good, but there is duration risk.

“We like A-rated munis,” he said. “And we like the long end, because of the structures you can get there.”

Yields have fallen precipitously at the intermediate and long ends of the curve since October, Municipal Market Data numbers show. The 10-year triple-A yield has plunged 21 basis points over the period to 1.54%. The 30-year has plummeted 28 basis points. Both keep breaking record lows.

By comparison, the two-year has frozen at 0.30% the entire span.

Issuance since October has also been lighter than its historical average, typically arriving well below $7 billion and brimming with refunded paper. As investor demand has remained robust, yields have been driven ever downward.

For the BlackRock Municipal Bond Management Committee, the coming holidays and the remaining uncertainty about the fiscal cliff mean a likely period of volatility to come. Supply, they wrote in a research report, is likely to rise toward year-end, but not sufficiently to quell demand.

Like DWS, BlackRock also maintains a duration-neutral stance.

“Overall,” they wrote, “we are focusing on income and capital preservation, as the majority of the market’s capital appreciation potential has likely been realized this year.”

The trends the market has seen this year, namely tighter credit spreads and a slowly flattening yield curve, will continue over the next couple of months, said Matt Fabian, managing director at Municipal Market Advisors. As such, longer-maturing high grades are overbought. In the near term, it may be tempting to look at high-yield spreads and mid-grade spreads. But high grade munis are likely revert to their mean before high-yield or mid-grades can rally or catch up, he added.

Longer-term, or over the first half of 2013, Fabian said MMA likes bonds further out the high-grade yield curve, from a perspective of total return. The firm expects muni yields will rise over next couple of years.

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