Municipal bonds were hit by a month-long selloff after the Presidential election that left muni fund managers licking their wounds.
"For most municipal bond indexes, the November negative returns more than wiped out the previous 10 months' total return," said Dorothy Thomas, senior vice president and director of tax-exempt fixed income for Regions Investment Management. "In addition, the effect of sudden selling pressure tested market liquidity and put more downward pressure on bond prices."
Muni yields, which move inversely to price, surged on concern that Donald Trump's victory in the presidential race and Republican control of the House and Senate would open the way to tax reforms that dissipate the value of – or eliminate – the bonds' tax exemption. The S&P Municipal Bond Index finished down 3.46% in November, the worst monthly total return since September 2008, according to S&P Dow Jones Indices.
The Robinson Tax-Advantaged Fund was among the long, closed-end funds that got hit "pretty hard," according to fund manager Jim Robinson, founder and chief investment officer of Gross Pointe Farms, Mich.-based Robinson Capital Management.
"We were down 4.39% since the election through Monday's close," he told The Bond Buyer on Dec. 7. "We've since seen a strong recovery – up 2.73% since [Dec. 5] – as the underlying municipal bond market has finally caught a bid.
"I think the market has finally figured out that it had overcorrected and we are now seeing it make up for that."
Robinson's $150 million fund hedges duration risk with short positions in U.S. Treasury futures contracts to avoid making interest rate bets and remain rate agnostic. It typically offers a 4% tax-exempt monthly yield distribution, Robinson told The Bond Buyer before the election.
"There's always a loss to harvest because of the hedging, on one side or the other munis or Treasuries are going down in value," Robinson said in a Nov. 4 interview with The Bond Buyer. While the recent price depreciation in municipals and Treasuries was challenging, he said his strategy still proved effective.
The level of Treasury yields at any point in time is less of a concern than the relationship between municipal bond yields and Treasury yields, Robinson said. The fund's strategy measures relative value by comparing the yield to worst on the Barclays Investment Grade Municipal Bond Index to the yield to worst for the Barclays Aggregate Investment Grade Corporate Bond Index.
On Election day, for instance, the yield to worst for the municipal index was 1.99% and the yield to worst for the corporate bond index was 3% -- meaning municipal yields were roughly 66% of taxable corporate bond yields, Robinson said. On Dec. 2, the yield to worst for the muni index was 2.84% and the yield to worst for the corporate bond index was 3.40%, indicating muni yields rose to nearly 84% of their taxable corporate counterparts in a little less than a month.
"That's a much bigger move than the 9.8% decrease in marginal tax rates that Trump has proposed," Robinson said.
Trump's plan calls for the reduction of the current seven tax brackets down to three, lowering the top marginal rate to 33% from 39%, eliminating the 3.8% Affordable Care Act tax, and capping itemized deductions at $100,000 for individuals and $200,000 for couples.
"Regardless of the anticipated decline in the marginal tax-rate and the recent rise in yields, we believe our 4.35% distribution yield, which we distribute monthly, remains competitive for investors looking for tax-exempt income with minimal credit or interest rate risk," the Robinson fund CEO said.
Investors have continued to pull money from munis, as weekly reporting municipal bond funds saw outflows of $2.214 billion in the week ending Dec. 7, according to Lipper data.
But the most recent week's outflows have slowed from last month. In the week ended Nov. 16, investors withdrew $3.011 billion, according to Lipper data, the biggest outflow in more than three years, the fund tracker reported.
The cash exit was followed by two additional weeks of total outflows among the weekly reporters – $2.232 billion in the week ended Nov. 23, and $2.081 billion in the week ended Nov. 30, according to Lipper.
The 54-week inflow frenzy of 2016 came to an end thanks to "a perfect storm of negative fund flows, higher rates, cheaper relative value ratios, and wider credit spreads" as the election neared, according to Jeffrey Lipton, managing director and head of municipal research at Oppenheimer & Co., in a Dec. 5 report.
"The selling pressure did not stop until the tax-exempt curve exceeded the Treasury curve across all maturities and, over the past three to four days, we've witnessed a significant rebound in the market," Triet Nguyen, head of public finance credit at NewOak Capital, said in an interview on Wednesday.
"That said, further retracement of recent losses may be capped by year-end bond swapping to harvest tax losses and further redemptions from fund investors upon receipt of their November account statements.
"The last 25 to 30 basis-point rise in the curve … can arguably be attributed to a technical overshot due to fund selling pressure, heavy dealer inventory, and perhaps reduced market liquidity overall," Nguyen said.
Michael Belsky, senior portfolio management director at Morgan Stanley Wealth Management's Vector Group, said recovery could be challenging for some funds in the aftermath of the sell-off.
The market had been volatile since the election, causing a string of sessions in which municipal yields spiked -- 22 basis points on Nov. 14 and 10 basis points on Nov. 30, for instance. Meanwhile, ratios of triple-A municipals to Treasuries had soared above 100% from 10 through 30 years, according to MMD.
"If closed end funds sell off hard, they have the potential to bounce back if the asset class starts to be favored by investors," Belsky said. "But liquidity in [closed-end funds] is sometimes an issue because they don't trade in high volume."
As a fixed income portfolio manager in the 14-member Vector group he co-founded in 2009, Belsky oversees $120 million of individual municipal bond holdings in Vector's Bespoke Customized Portfolios.
"The Trump Tantrum not only continues to drive market behavior, but performance for the year seems as though its beginning reference date is Nov. 8," according to Lipton.
"The bond rout is very much reminiscent of the 2013 Taper Tantrum," when 10-year Treasury yields surged about 135 basis points and investors reallocated money into risk assets, Lipton said.
Other fund managers said the market's reaction to the election was painful, but pointed to opportunities amid continued volatility, even as the municipal market remains wary of Trump's tax plan and general uncertainty over government spending and inflation.
"Everyone looked at where they thought interest rates would be a year after Trump was in office and moved to a terminal rate – almost immediately," John Mousseau, director of fixed income at Cumberland Advisors told The Bond Buyer on Wednesday.
"In the end, it was fear of inflation – rather than inflation – which killed the market," Mousseau said. "The fact that $40 billion of bond fund inflows came in this year, it made for a swift exit of at least a quarter of it."
Outflows from bonds funds are putting additional, longer-term pressure on the municipal market, "However, the activity suggests yields are beginning to look attractive," said J.R. Rieger, managing director and global head of fixed income at SPDJI.
While the municipal market has seen a spotty recovery, Lipton said there may be more volatility ahead.
"We still do not believe that the substantial back-up in yields, over such a brief time period, provides an appropriate interpretation of the Trump agenda," Lipton wrote. "We may very well see some additional weakness with continued outflows."
Municipal bond losses may reflect more uncertainty about future tax policy changes under a new regime, agreed Thomas at Regions Investment Management.
She said the municipal market experienced a bigger sell-off than other fixed income sectors as yields were affected by increased prospects for economic growth and higher inflation as other markets were.
Thomas said Regions – a registered investment advisor that oversees the management of $9.91 billion in client assets as of Sept. 30 – is not changing its defensive strategy of relatively short maturity structures, high coupons, and strong credit quality for its municipal bond portfolios, since it anticipates further increases in interest rates ahead.
She also wouldn't characterize the municipal market as oversold as opportunities could arise at new levels. "More volatility around policy uncertainty and illiquidity may lead to buying opportunities when the market retreats" she said on Thursday.
Despite the market volatility, bond funds are a better bargain than they were ahead of the election, Mousseau of Cumberland said.
"Bond funds are a bargain in the sense that they got clobbered in the downdraft," he explained. "Selling begot more selling and the drop in the NAVs became a negative feedback loop – not unlike the 2013 Taper Tantrum."
The sell-off put individual bonds in greater demand by unleveraged bond fund holders, as the individual bonds could be purchased with yields of 4.25% or higher, Mousseau said. "The flexibility of owning individual bonds gives different options if cash needs to be raised. On the contrary, if one only owns bond funds they are subservient to one price and one price only – the NAV of the bond fund -- which was plummeting."
"A substantial rally is now underway in municipal bonds that was easily predictable to most trained observers," Michael Pietronico, president of Miller Tabak Asset Management, said in an interview on Wednesday.
On Wednesday, the market saw a significant correction as 10-year municipal yields dropped 30 basis points and the 30-year municipal yields had declined by 28 basis points, picking up steam after initially beginning to rally on Dec. 2. Wednesday's rally was interrupted Thursday as yields on top-quality 30-year maturing municipal bonds rose by as much as three basis points from 3.07%, according to Municipal Market Data.
“The entire U.S. bond market was caught off guard by the victory of Donald Trump and, as such, a back-up in yields needed to happen to adjust to the reality of a newly-elected President with both chambers of Congress held by the same party,” Pietronico said.
"The problem we have with the sell-off in municipal bond prices is that it far exceeded that of the Treasury market and, at its worst, tax-free bonds were valued as fully taxable, which is unsustainable in our view," Pietronico said.
"Municipals typically outperform U.S. Treasuries in periods of price erosion," Lipton wrote. "But the current sell-off is rather atypical and can be heavily linked to certain political and fiscal assumptions that may be difficult to quantify."
