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As Tax Season Fades from View, Fund Flows Should Return to Form

The sun should soon set on the outflows municipal bond mutual funds have been seeing for the past couple of months.

Weekly reporting muni bond funds recorded outflows of $102 million for the week of April 24, the eighth such week of negative flows, Lipper FMI numbers showed.

But now that tax season has passed, industry watchers anticipate the outflows to fade soon and interest beyond the front end of the yield curve to rise. The next few weeks should determine the level of investor demand going forward, they said.

Year to date, flow numbers have mostly fallen to less than half of what they were in 2012 across all categories. Through April 10, $7.4 billion has flowed into muni bond mutual funds; through the same period in 2012, it was $16 billion of inflows.

Still, the latest Lipper numbers bode well for market demand, said Chris Mauro, director of municipal bond research at RBC Capital Markets.

"The outflows are definitely moderating," he said. "And that, coupled with moderation in equity inflows, is a good sign for munis."

It's still too early to know where they're going, Mauro added. Diving into the week's numbers showed a clean print, with no big outliers and no identifiable fund or subcategory of funds that would account for either a large number of inflows or outflows.

"It was a fairly diverse set of numbers," Mauro said. "So it's really hard to say."

Chris Ryon, managing director and co-portfolio manager of muni funds at Thornburg Investment Management, agreed. May should present the first real read the market gets, he said.

Lipper data showed that, for the weeks leading up to tax day, flows are returning to the short products, Mauro said. Numbers were in the black modestly for last week after two huge weeks of outflows there.

"That indicates that people were using the ultra-short products for near-cash equivalents, and accessing those to satisfy their tax bills," Mauro said.

Investors had moved out the yield curve to get more income. And to pay their taxes, Ryon added, they had to sell those assets, come back into a money fund, and write a check.

Typically, though, this scenario plays out over a week or two, not eight, John Dillon, chief municipal bond strategist at Morgan Stanley Wealth Management, wrote in a research report.

Muni industry watchers anticipate investors will return to their yield hunt. Accordingly, they'll move out the yield curve and down the credit spectrum, Ryon said.

"I would suspect they're going to continue the same type of behavior that they've shown in the past," he said. "The retail investor has a long and well-documented history of chasing last year's returns."

There is value to be found in the longer investment-grade national market funds and intermediate funds, said Phil Condon, chief investment strategist and lead muni portfolio manager at Deutsche Asset and Wealth Management. But not in the high-yield sector, he added, which has gotten rich.

"The last three years have been very good to the high-yield funds, especially the aggressive ones," Condon said. "And so, I've heard some investors say 'OK, I've gotten my return; now let's try something else.'"

But if munis yields stabilize or rise, flows to intermediate- and longer-maturity funds may be light for a time, wrote Citi muni analysts George Friedlander and Vikram Rai in a research report. For one, direct retail investors continue to be wary of jumping in from the sidelines with their money following the most recent rally.

"Rate shock appears to be widespread," the two wrote, "and it could take a significant increase in yields - say, back to mid-March levels - to generate significantly more enthusiasm from the direct retail buyer."

Munis have seen light trading and little movement in the triple-A yield curve since April 19, Municipal Market Data numbers showed. By comparison, they outperformed Treasury yields at the long end of the curve largely through their inactivity.

The 10-year triple-A yield at Friday's close slipped one basis point over the period to 1.69%. The 30-year fell three basis points to 2.87%, while the two-year held at 0.29% for the 16th straight session.

Muni ratios to Treasuries at the 10-year and 30-year portions of the curve hovered around 100% by Friday's close. The two-year ratio froze at 126% for the week.

Assets for all muni funds that report their flows weekly fell for the second straight week to just under $326.4 billion. The week prior, they reported slightly more than $326.4 billion.

The value of the holdings for weekly reporting funds rose by $43 million. The week before, they rose by $447 million.

The four-week moving average for all municipal bond mutual funds that report their flows weekly was $386 million of outflows, compared to $372 million in outflows the week before.

Long-term bond funds that report their flows weekly continued to see outflows, at just $132 million. This is a drop from last week's numbers, when they reported $49 million of outflows. High-yield muni funds recorded outflows of $86 million after two consecutive weeks of modest inflows.

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