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Investors Flocked to Muni Bond Mutual Funds

JAN 17, 2013 5:19pm ET

Municipal bond mutual funds saw $43 billion in inflows in 2012, a huge increase over flows of the previous two years.

As a proxy for investor demand, muni bond fund flows indicated solid interest for the asset class throughout the year, according to Mark Tenenhaus, director of munic research at RSW Investments.

“When you look at the low interest-rate environment and the various uncertainties that surround all asset classes, munis still have had a very strong year and a very good, strong appeal to the individual investor, despite everything that’s in the background: tax increases, uncertainty, low interest rates,” Tenenhaus said.

Still, many of the inflows last year resulted from bonds being called away from owners, retired or refinanced due to extremely low interest rates.

“The coupon payments and principal redemptions and bond calls that we had last year were just at a very significant level,” said Chris Mauro, director for municipal bond research at RBC Capital Markets.

If last year was any indication for the effects low rates had on the market, 2013 could bring more of the same if rates linger around current levels. January is shaping into a big one for coupons, regularly scheduled maturities and early redemptions, according to RBC Capital Markets numbers. For fixed-rate muni debt, the number amounts to $29 billion.

There were $18.8 billion in inflows to long-term muni bond funds last year, Lipper numbers showed. These were up from outflows of $19.5 billion in 2011 and $7.8 billion in 2010.

In 2012, the market saw more money come into long bond funds than it had in earlier years, Mauro noted. At the start of the inflow period in September of 2011, a lot of money flowed into short and intermediate products. By the end of 2011 and into 2012, though, a large proportion of flows poured into the long-end bucket, as well as its high-yield subsector.

“So, obviously people were trying to move out the yield curve and down the credit spectrum to pick up some incremental yield,” Mauro said.

High-yield muni bond funds also saw inflows last year, to the tune of $8.5 billion. That compared with outflows of $2.2 billion in 2011 and inflows of $300 million in 2010.

The Huntington Ohio Tax-Free Fund saw an uptick of investor money flow in last year, according to Kathy Stylarek, a senior portfolio manager and head of tax-fee funds at Columbus, Ohio-based Huntington Funds. Assets under management for the fund closed out 2012 at $54.04 million, growing almost $10 million, according to Stylarek.

Why? “Well, it’s hard to find bonds,” she said.

On the year’s deals, large asset-management firms often determined prices, Stylarek said, setting many at high premiums with coupons over 4%. And many retail customers were hard-pressed to buy at $120 dollar prices, she added.

“So, the only market that they could really participate in and feel comfortable that they were buying at par would be a fund,” Stylarek said. “Not to mention, they could get better diversification.”

In 2011, there were $15 billion in outflows. Most represented fallout from negative headlines in the muni space that started at the end of 2010, notably analyst Meredith Whitney’s prediction near the end of that year of massive municipal defaults set to occur in 2011. Her call, which did not come true, followed news of $22 billion in tobacco bond downgrades, also in late 2010.

The downgrades touched off a panic. Every week after the tobacco bonds downgrades, money hemorrhaged from muni bond funds, often at weekly rates exceeding $1 billion.

At its height, on the week of Jan. 19, 2011, investors in weekly reporting funds pulled more than $4 billion, Lipper reported.

The outflows mostly came to a halt in September of 2011.

Looking forward, uncertainty over the industry’s tax-exempt status sits high on investors’ minds, and could influence demand for munis. But asset rotation stands as another factor that could affect inflows, Mauro said.

It has yet to play a role in the market, he added, but could this year, given how large inflows to equities were last week. “That’s not just a muni story; it’s a fixed-income story in general,” Mauro said. “We’re keeping a close watch on that.”