The 19 consecutive weeks of inflows into municipal bond mutual funds -- and more than $4 billion year to date -- is evidence that investors are still seeking shelter from volatility in other asset classes, creating new opportunities for mutual fund managers like Jeffery Elswick.
The municipal market, which is usually the last to rally or sell off, remains an outlier in early 2016, Elswick, the director of fixed income and portfolio manager at Frost Investment Advisors LLC, said in an interview.
"The municipal space held up very well in terms of yields and returns while other segments came under stress," he said.
The inflows continue to fuel the municipal mutual fund market and provide Elswick with the necessary cash flow to upgrade credit quality and minimize both duration and credit risk in his $260 million Frost Municipal Bond Fund.
Investors seeking an alternative to other asset classes have poured $4.73 billion of inflows into municipal bond mutual funds so far this year, according to Lipper data released on Feb. 12.
In the 19th straight week of positive inflows, weekly reporting municipal bond funds received $940.697 million of new cash in the week ended Feb. 10, Lipper said. That compares with inflows of $673.322 million in the previous week.
Much of the increased demand for municipal mutual funds has surfaced as investors rebalanced holdings to shelter themselves from domestic and overseas volatility, according to Elswick.
The stress in other asset classes has boosted municipal demand since the latter part of 2015, following a stagnant second and third quarter, he said.
That steady inflows helped the municipal market close the year in center stage, where it remains, Elswick said.
Tax-exempt securities tracked by Municipal Market Data continue to outperform comparable U.S. Treasuries at a yield ratio of 95% for 10-year paper, and 105.2% for 30-year paper as of Feb. 11, according to MMD. The ratios have averaged 88% and 97.7%, respectively, since November 16, according to MMD.
Like municipals, Treasuries and asset-backed securities performed well, but other asset classes "came under a fair amount of selling pressure," Elwsick said.
For instance, the corporate market was among the hardest hit, with high-yield corporate bonds posting some of the poorest performance since the financial crisis, he said.
Given the volatility in other classes, Elswick is maintaining a conservative investment approach, and using a barbell strategy to minimize his long exposure and find value between the ultra short end of the municipal yield curve and seven and 10 years.
"We are not investing in a lot of 20 to 30-year maturities" due to the low absolute yields, he said.
His fund is strictly investment-grade and avoids lower-rate credits and riskier investments, he said.
"Within the world of muni bonds and investing we want to be more conservative -- even more than we have been," Elswick explained.
As a result, he is focused on more higher quality paper, such as public universities in Frost's home state of Texas , including double-A and triple-A-rated public universities like the University of Texas, Texas A&M University, and Texas Tech, as well as school district bonds backed by the Texas Permanent School Fund guarantee.
Depending on the issuer, triple-A paper due in 10 years has a 20 to 25 basis-point yield spread to Treasuries, he noted.
"We can get really comfortable with the underlying credit transparency and high disclosure," Elswick said.
With economic data lacking strong evidence of a dramatic rise in inflation or interest rates any time soon, he said investors are getting accustomed to the current rate environment and looking for opportunities to spend available cash.
"We do think at some point interest rates will move a little higher," Elswick said. "But, in general, the market seems to be coming to a more concrete thinking that yields are going to stay pretty low for a while."
He predicts the Federal Reserve Board will raise rates once more in the summer of 2016 with little expectation of a March hike – barring any severe financial distress in other asset classes.
"If some of the stress we are seeing in other markets and commodities continues to come under pressure – and become more stressful financially – then they are going to have to change their position in March," Elswick said.
