With municipal bond supply down by nearly a quarter from last year, investors have been coming up short as they try to roll over the proceeds from June 1 and July 1 called and maturing bonds, municipal managers and strategists said.
Even after a spike in volume this week to a three month high of $8.6 billion, the supply shortage in the tax-exempt market in 2014 is making summer reinvestment season especially challenging for cash-laden investors, the experts said.
"The reduced supply is different this year because the lack of supply has been so persistent and unrelenting," said John Donaldson, vice president and director of fixed income at The Haverford Trust Co. in Radnor, Pa.
"This has been a full-fledged drought, not merely a dry spell," he said. "As with a drought, the impact is longer lasting and results in changes in behavior to compensate for the lack of supply."
The drought is forcing buyers to tweak their strategies or find temporary investment alternatives for upcoming bond proceeds, municipal experts said.
"It's been very much a struggle," said Dan Heckman, senior fixed income strategist at U.S. Bank Wealth Management in Kansas City. "In certain segments of fixed income - especially municipal bonds - there is more money floating around than bonds to meet that demand.
"There are some deals out there that are able to satisfy some of that reinvestment demand, but our greatest concern is what happens after this week," Heckman said on Tuesday, as the Los Angeles Unified School District prepared to begin pricing later in the week of its $1.7 billion general obligation offering.
The deal was the biggest of the week and largest since Puerto Rico's $3.5 billion GO sale in March.
Overall, year-to-date issuance has declined by 24.8% to $115.14 billion in 3,959 issues through May 31, from $153.03 billion in 5,505 issues over the same period in 2013, according to data from Thomson Reuters as of June 4.
Jim Grabovac, managing director and senior portfolio manager at McDonnell Investment Management in Oakbrook, Ill., pointed to a steady decline in total annual municipal volume in recent years, as tax rates and demand for munis climbed. For instance, issuance fell to $333.73 billion in all of 2013 from $379.60 billion in 2012. That was down from a decade high of $433.26 billion in 2010, according to Thomson.
This year, inflows into municipal mutual funds are beginning to accelerate after a period of outflows in 2013.
"This year has been the exact opposite of last year," Grabovac said. "Inflows are coming back in, not at the pace of a couple of years ago, but they are building as the year goes on."
The market has done "a 180," several muni pros said, from the selloff, which was triggered by signals in June from after former Federal Reserve Board chairman Ben Bernanke that the Fed planned to taper its economic stimulus program.
"Supply was kind of somewhat muted last year, but not like it's been so far this year," Heckman said. "We have an environment where interest rates seem a lot more tame and not that volatile. It's more challenging this year than last year if you have to put money to work."
The deficiency has some fixed-income money shifting into the equity market, while other investors have opted to park cash in tax-exempt money market funds, Heckman said.
The 420 weekly reporting tax-exempt funds reported inflows of $1.05 billion for the week ended June 9, bringing total net assets to $257.46 billion, even though the average seven-day yield remained unchanged at just 0.01%.
The inflows followed outflows of $692.4 million in the previous week, and a loss of $1.54 billion of cash in the week ended May 26, according to iMoneyNet.com.
Before last week, Heckman said there was a "steady drip out of money markets," but with a lot of money still on the sidelines, he expects more cash to seek temporary shelter.
Donaldson of Haverford said he is suggesting clients adapt two temporary strategies to get around the scarcity: extend their maturities roughly two years longer than usual, and reinvest between 10% and 20% of their proceeds by crossing state lines.
"We strongly prefer those two options rather than dropping down in credit quality or paying super-high dollar prices for bonds," he said.
Donaldson said clients in Maryland and Florida, for instance, are opting to sacrifice some tax efficiency and invest beyond state lines when and where bonds are available.
"We have found acceptable value in general market states such as Texas, Massachusetts, and Washington," Donaldson said.
California, meanwhile, has experienced a 45% reduction in supply versus last year's pace, he noted. "We are communicating that this reduction in the state with the most issuance has a clear impact on all of the broad market indices," Donaldson said.
With investors expecting July 1 redemption proceeds in a little over two weeks, some managers fear the sluggish supply will persist far longer than the end of the seasonal summer buying period.
"The November election in the rearview mirror will be a benefit to potential issuance rather than a reason to put things off," but, otherwise, Grabovac predicts supply concerns to linger for the balance of this year.
"The need for issuance is really a temporary situation being influenced strongly by the political dynamics of pro-austerity as it relates to spending and investments," he said.
Donaldson argued that supply could improve with the arrival of July 1.
"So many state and local governments operate on a June 30th fiscal year that it is possible that they could bring 2015 financing needs a little forward to take advantage of the favorable market," Donaldson said.
Heckman, however, said he believes the decline in supply may carry over into the first part of 2015.
In either event, investors aren't likely not succumb to the drought and boycott the market altogether.
"We have not taken any money off the table in municipal bonds," Donaldson said. "However, we are not pushing to rebalance any accounts to put additional funds into a market with sharply reduced supply."
Heckman agreed. "People are staying fairly disciplined, picking spots that make sense," he said. "And the back up in rates has been helpful.
"We are trying to be patient and when we find opportunities in the new-issue and secondary markets we go after size and capture those bonds," Heckman continued. "We view that patience and discipline will pay rewards until we get a better environment where it's a buyer's market, rather than a seller's market right now."
