After more than 25 years in the municipal bond industry, Chris Ryon has navigated through plenty of volatile market periods. He's steered past everything from the 1987 bond and stock market crash, to the 1994 Orange County bankruptcy, from the Sept. 11, 2001 terrorist attacks, to the 2008 financial crisis, and more recently the 2013 Taper Tantrum.
So it's no wonder the managing director and portfolio manager at Thornburg Investment Management is cautious about the current flattening yield curve, the credit turmoil surrounding Puerto Rico and Illinois, poor liquidity, and the uncertainty over the pace of interest-rate hikes by the Federal Reserve Board.
In light of such concerns, he advocates favoring the safer end of the risk spectrum, keeping durations lower than usual, and maintaining higher reserve positions on the seven municipal bond mutual funds totaling $11 billion he manages for the Sante Fe, N.M.-based asset management firm since 2009.
"We're not taking any excessive risk in any of the portfolios," Ryon told The Bond Buyer in an interview this week. "We don't think we are getting paid to take risk, so we are taking less of it."
That means he is limiting investments to securities rated between A-plus and AA for the muni funds.
"One value metric we use, 'real yield,' indicates the market is a little pricey right now," he said. For instance, Ryon said 10-year triple A general obligation bonds currently offer investors a spread of between minus five and zero basis points over inflation.
"Credit spreads are back to where they were in 2006," Ryon said. "On top of that the credit covenants are extremely weak."
Ten years ago, he said, 60% of new municipal bond issuance was coming to market with triple-A insurance from at least two of the major rating agencies.
"It's a great time to be an issuer – not a great time to be an investor," said Ryon, who joined Thornburg in 2008 and also manages $1.3 billion in separately managed accounts for high net worth retail investors. "I can't seem to make a case for wanting to overweight fixed income and municipal bonds specifically in anyone's portfolios."
Still, Ryon said the overall underlying credit picture in the municipal market has improved and municipal returns in recent years have provided tax advantages to high net worth investors.
For example, monthly returns from Jan. 1, 2013, through August 2016 with a standard deviation of 1% show a 20% reduction in volatility, according to Ryon. "That's the reason to own fixed income and munis in a well-diversified portfolio," he said. "In a period such as we are in now, one of extreme uncertainty, diversification is one of the best risk management tools an investor has."
The Thornburg funds, he said, are managed with a team approach using a fundamental bottom up research technique when purchasing new municipal bonds or analyzing those they already own.
The team approach is most important during volatile market periods when deciding whether to sell a particular holding, according to Ryon. The team works on portfolio management, as well as quantitative analysis, and credit research.
"If we like the credit story, we maintain those because we don't want to disrupt the dividends since they were purchased in higher-yielding environments," he said.
Despite Chicago's recent fiscal troubles, the team approved buying uninsured Chicago GO bonds in the Strategic Municipal Income Fund when they were yielding 300 basis points over the MMD triple-A GO scale.
"They have raised real estate taxes, and have exhibited a willingness to pay," Ryon said of the city of Chicago, which is junk-rated by Moody's Investors Service as a result of projected deficits and financial burdens, such as a net pension liability of $34 billion.
The state of Illinois is another story, he said. "We are not buying it at these levels because they look completely ungovernable."
Lately, his funds have seen marginal cash flows coming in, which has enabled him to execute his strategy of upgrading credit quality without much need to sell paper.
Ryon says his use of a laddered portfolio strategy helps maximize shareholder income when there are fewer yield opportunities in the municipal bond market.
"Overly accommodative central bank policy has forced investors – both institutional and retail – to move out the risk spectrum in search of income," Ryon said.
Still, "value metrics, such as real yields, credit spreads, and the slope of the yield curve, are all flashing red," he said. "Extending maturity and buying lower quality bonds at higher prices typically doesn't end well."
He recommends keeping credit risk low with ownership of single and double-A securities, and duration at the lower ends of neutral – or in a bearish range depending on the portfolio – while maintaining as much as double the normal reserves to shield portfolios against interest rate movements in a liquidity-weak market.
Reserves are highly-liquid variable-rate securities and notes that can be quickly converted to cash.
Poor market liquidity can result if the market goes into a period of distress, as it did during the 2013 Taper Tantrum, when investors reacted to talk that the Federal Reserve was winding down its quantitative easing program .
"The liquidity in all fixed income markets is pretty weak," he said. "Just look at headcount reductions, and balance sheets.
"Though some of the [exchange traded funds] are trading at close to a 3% discount to [net asset value], we wanted to be cautious," Ryon said, referring to 2013 in the midst of the taper tantrum.
Ryon said he is poised to use a portfolio's reserves to meet client redemptions if needed, or if rates move higher. If the market comes under pressure, he wants to be able to buy securities.
Additionally, he said laddered portfolios outperform barbell or bullet strategies 60% to 70% of the time and offer a tax-advantaged, efficient long-term structure that has resulted in the addition of 15 to 20 basis points of annualized total return over the last two decades.
"When we see an increase in interest rates, a laddered portfolio will respond well. It will initially suffer a decline in NAV based on its duration and the interest rate changes in its investment universe," Ryon said. Then its recovery will be steady as cash is generated "organically" as securities mature and will be deployed at higher rates.
"In this environment, the turnover is low, the transaction cost is low, and the capital gains are managed to zero by using the ladder," Ryon added. "It allows us to focus on higher value-added decision making and fundamental bottom up credit research."
The six-member municipal bond team has two portfolio managers, including Ryon, and it manages six of the core municipal bond funds as high-quality, laddered portfolios, including:
- the Low Duration Municipal Fund;
- the Limited Term Municipal Fund; the Intermediate Municipal Fund;
- the California Limited Term Municipal Fund; the New Mexico Intermediate Municipal Fund; and
- the New York Intermediate Municipal Fund.
The $308.1 million Strategic Municipal Income Fund has the most flexible mandate to invest across a wide range of maturities and credit qualities. The fund, which held 224 bonds as of Aug. 31, can own up to 50% in sub-investment grade paper – yet it is not a high yield fund, Ryon is quick to point out. It has the longest effective duration at five years and average effective maturity of 10.4 years as of Aug. 31, according to the firm's website.
The fund's largest holding – 34.2% -- is in single A bonds, followed by double A at 28.2%, and BBB at 14.7% as of Aug. 31. Below investment grade credits represented 1.9% as of that date.
Ryon said the team approach offers a broad-based, multi-perspective view of the entire market.
"Someone might like a hospital credit, so we look at that credit against the broader market, not just a narrow sector," Ryon said. That approach "more closely aligns our interest with that of the shareholders."
Since inception in 2009, the A shares of the strategic fund posted a 7.25% average annual total return without a sales charge as of Sept. 30, according to data on the firm's website. It also posted a year-to-date average annual return of 3.30%, and a one-year and three-year average annual return of 4.63% and 5.21%, respectively, according to Thornburg data.
It also posted a 30-Day SEC yield of 0.59%, and an annualized distribution yield of 1.72%, with a sales charge, as of Aug. 31, according to data on the firm's website.
Ryon, who is a member of the board of directors of the Municipal Securities Rulemaking Board, said the firm's municipal mutual funds are being managed with a cautious stance and a laddered approach – regardless of the future of interest rates.
"We are not waiting on the Fed moves," he said. "I don't think that the deadline of the year end is going to change much. We are not changing our view of the world going through year end. If we see opportunities present themselves, we will reevaluate our positions."
