Doug Vissicchio, Head of Municipal Trading at UBS, sits down with Bond Buyer Executive Editor Lynne Funk to discuss the importance of a retail network, liquidity risks and opportunities, and broader market expectations for 2024 amid macroeconomic challenges.
Transcription:
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Lynne Funk (00:09):
Good morning everyone, and welcome to this Bon Buyer Leaders Forum. I'm Lynne Funk, executive editor at the Bon Buyer, and today I am delighted to welcome Doug Vissicchio. He is head of Muni trading at UBS. Prior to UBS, Doug was co-head of Muni bond trading at Citi, where he led a large team across all sectors in the market while managing significant positions in taxable munis. Throughout his more than 30-year career, Doug has built a deep expertise in taxable and high-yield muni sectors. He most recently was asked to join the Bond Dealers of America Board. Welcome, Doug.
Doug Vissicchio (00:47):
Thank you so much for having me today.
Lynne Funk (00:49):
It is great to have you. So I think a lot has been discussed in the industry particularly, and in the pages of the Bond Buyer, about UBS's exit from the negotiated space in muni public finance business. But I'll say from my seat here, and perhaps we haven't done a really good job explaining maybe why you're here with me today, and that is because you still are in the muni business, you and your team. So let's start perhaps with an overview from you for those of our audience who might not know what it exactly is you are running point on at UBS. Sure.
Doug Vissicchio (01:25):
Yeah. So I joined UBS about three and a half years ago to build out and to grow our capital markets group, mostly focusing on trading credit analytics, competitive underwriting. When the firm made that decision to exit public finance, as my management told me, you now became exponentially more important to UBS because we have large and distinct investor groups that need to be serviced and to provide liquidity. Over the course of the last three plus years, we've added to staff in sales, in trading and credit analytics and as well as competitive underwriting. And we've seen some great results. We've doubled our trading volume over the course of that time. And we've also onboarded tender option bond program, which we are looking to grow and also competitive underwriting. We hired a terrific competitive underwriter and we've seen some great results there as well.
Lynne Funk (02:42):
So why is it so important that you are still bidding in the competitive space?
Doug Vissicchio (02:47):
Yeah, I mean, competitive is super important for us. We want to stay strategically important to our clients and this is one great avenue to provide product. In addition to that, it helps to see where the demand is in the market. When you bring a deal, you can see who's buying and what type of structures they're buying, which is also important and it is a way to service issuers as well. Even though we're not in the negotiated space, bidding competitively for issuers deals does provide a service to the issuer side of it. And again, there we've had some great accomplishments. This year alone, we're in the top 10 of competitive underwriting. We've bought 18 deals, we're up 17 spots in the ranking. We've purchased right around a half a billion in competitive. And so this has been a great success story for the desk.
Lynne Funk (03:46):
Nice. And we'll get into a little bit more about how that ties into some other aspects of the business, but I kind of want to talk about demand first. The shifting demand in the market uni bond fund flows. We saw big outflows in 2022, some in the last year, a rebound so far this year, last week outflows, but perhaps that's maybe more tied to tax season than shifting people shifting out. What can you talk about, what about the reallocation of money though? Are mutual funds still as a big player in this space?
Doug Vissicchio (04:19):
Yeah, I mean, mutual funds are incredibly important to the functioning of our market. When you look at the category of mutual funds in ETFs, that's about 25% of the market and that is about 1 trillion in ownership in those two categories. And so ETFs have certainly taken a little bit of the spotlight in terms of the growth there, but it's only about 3% of the overall market, about 125 billion of that category. One of the things you need to remember is that when yields increase dramatically, mutual funds need to catch up a little bit by doing swaps within the portfolio, they have to distribute at book yield. So until they can cycle through into new and more modern yields, individual bonds become just a higher yielding product for an investor. And so what we saw in 2022 when the funds lost somewhere in around 125 billion was sort of that migration, that migration from mutual funds into individual bonds.
(05:38):
And again, their ETFs actually grew in that time period. Actually, if you go back one year from 22 and 21 mutual funds brought in a hundred billion. And so it was just a little bit of the timing and the ascent of yields that occurred in 22, 23. It started to smooth out. They did still lose some amount of money, I think in the 10 billion camp. And this year they've regained that 10 billion again most likely because they've been able to do those swaps to get a higher yield in those funds and then better compete with the individual bonds. If you look at the household segment, the household segment is by far the largest segment, and that includes SMAs. That's about 44% of the entire market, about 1.75 trillion in total ownership. And there we've actually seen growth and most likely from that SMA segment because that's in some cases in some reports as much as a trillion of that 1.75 trillion and so right, there's definitely growth there. Banks and insurance companies each somewhere around 500 billion, about 12% of the market have seen a little bit of consolidation in both of those as corporate tax rates came down to 21%, made it just a little bit less interesting for companies to own that. And then with the regional banking crisis, we've seen maybe some slowing down in bank buying. And then there's an international segment too, which is on the smaller side, but growing roughly 3% of the whole market.
Lynne Funk (07:29):
Right. You mentioned SMAs, which that's pretty substantial growth. They're usually short duration, mutual funds, longer duration. So can you talk about how perhaps this performance there is focused on the short end, how that's affected overall? Should issuers be changing the way they're looking at deals? If I'm an issuer and I know this segment has blown up, should I be thinking about that?
Doug Vissicchio (07:57):
Yeah, I think at broad measure, issuers don't have that flexibility. Traditionally, an issuer will issue level debt service. Basically it dlevers over time similar to a home mortgage that you're paying some amount of principal off through the life of that debt. And so if an issuer needs to maintain that level debt service because their revenues come in, not in bulky sort of one-time vents, but they come in similarly every year, whether it's a tax revenue or sales tax revenue. And so they need to have the debt service match with their revenue sources. So I don't think it's that easy for an issuer to change. The other thing I would say is that the yield curve is fairly flat. I mean, there's still some steepness to it. So the real benefit, I think there's 70 basis points between twos and thirties and MMD. There's not that much juice into just piling into the short end. You also take reinvestment risk when you do that. So if for some reason rates were to go higher and you're in the short end and then you've got to come back to market, you're taking some risk that potentially you have to issue at higher rates.
Lynne Funk (09:25):
How about we switch to high yield, which I know you know a lot about. So last week for the first time in 14 weeks, high yield funds saw some outflows, albeit relatively small, 43 million. But several folks have really commented on how the high yield sector has fared and it's really outperforming investment grade. You have a high yield trainer on your team. How does high yield fare going forward, do you expect outperformance there to continue, particularly if rates do go lower at some point? Yep.
Doug Vissicchio (09:54):
So this year I think the returns in high yield were around up a half a percent as opposed to down one point a half percent for munis. So definitely outperformance last year is even more pronounced up around 9.5% versus roughly six and a half percent for munis. So those are two solid years for high yield, and I think there's good reason for that. Credit is just strong right now. If you look at all the types of measures out there, it's justified from a credit standpoint. Also, new issue has been a little bit lighter in that sector as well. So the outperformance is certainly justified. Now, you can't continue to outperform every single year because eventually you do converge into the high grade segment of the market. But we do think that there's tremendous value in high yield. You need to be a credit selector in that part of the market.
(10:54):
But we do think there's opportunities. There was a recent deal for a casino out in Long Island. Long Island, yeah, those came around a 6% and rallied about 25 basis points. There was a pool deal for charter schools that came, and that deal rallied over time 125 basis points. So you can still doing credit selection, achieve outsize returns, buying high yield. And again, we see a lot of value there. Also, with the economy being strong, I think it's justified. I would say one thing on high yield for some credits, like smaller universities, we've seen some downgrades and even some defaults there or a weaker healthcare system that might have inflationary pressures from a cost standpoint embedded in their structures and an inability maybe to raise prices. That's the part of high yield, which could get a little bit more dicey. So credit selection is just important, but there's plenty of opportunities in high yield, but they're not going to be able to outperform forever.
Lynne Funk (12:08):
And what do you think about credit overall in general in this market after the Covid aid, the federal aid is drying up, issuers are, they don't have that cushion anymore. Are there any areas outside of healthcare or higher
Doug Vissicchio (12:23):
Ed? Well, I mean if you look at upgrades versus downgrades, for example this year, I think it's 2.9 to one, last year was three and a half to one. So we're still getting lots of upgrades in the muni sector. If you look at all the revenue streams that support municipals, state and local taxes are up 5% year over year. You've got property taxes are up 5%, sales taxes up 3%, personal income taxes up 9%, corporate taxes up 15%. So you've got all of these revenue streams which are showing great growth, and I think that's incredibly supportive for the whole sector. And so even though we don't think there's going to be a major downturn in the economy, I think if you look at municipal credit, it's healthy.
Lynne Funk (13:22):
So let's shift here to retail, which is had mentioned, we'll be talking about retail investors and I know you have a big business in retail. Can we talk a little bit, I guess first off, now we know the credit picture is pretty solid. Tax season's over retail investors yields are higher than what we've over the past 40 basis points since I think the six weeks at these interest rates. Do you see retail jumping kind of maybe back in?
Doug Vissicchio (13:55):
Yeah, so this tax season was a little bit different actually. We didn't see the wholesale selling. Now March was a little bit slow, which could have had something to do with taxes and the money market rates have been so high that I think people just had more liquidity and didn't necessarily have to go and sell. Now we did see that blip of a billion and a half outflows in the week preceding tax day. Most likely that's what that was from. But as you said, rates are high. And so U-B-S-C-I-O research is out with buy high grade fixed income and what a better product to buy than municipal bonds, especially with credit doing as well as it has been. I think the other thing people might be looking at is as we look towards the latter half of the year, the presidential election is coming up and certainly you could have some volatility in rates.
(14:58):
My guess is issuers may front load some debt issuance and not get in the way of the volatility around that. And then once that passes, you're going to see potentially a tailwind for munis on that as well. The other thing is, after paying your taxes, you've just felt the pinch of paying tax. And so it really brings out the benefit of municipal bonds. And so we always seem to get a bit of an uptick in purchasing after that event because people see the value in tax exemption taxes most likely are not going to go down again depending on how the presidential election goes. But generally most politicians and especially progressive politicians are putting forth plans to further tax the wealthy. And even though, and I read something the other day that said 1% of the income tax payers make up as much as 90% cumulatively. And so there's a wealth disparity in this country. But I do think the fact that there are a growing wealthy class will continue to bring interest into the product and we are seeing that post tax day. Okay.
Lynne Funk (16:35):
So can you talk about shifting ways of retail interest right now? What's structure coupon duration credit? What's retail focus on?
Doug Vissicchio (16:43):
Yeah, so again, UBS is out with a barbell strategy also by high grade fixed income. So when you marry those two with the flatness in the yield curve and short rates, we actually have some inversion in the very short end. We definitely see some buying in the intermediate side of it, but really the long end locking in rates at this part of the rate cycle, I think everyone recognizes that. Our retail certainly recognizes that. And when we get to structures like 4% at a discount, that becomes a very popular product for retail. Retail doesn't particularly love large premium bonds, but they do like par bonds and they do like discount bonds. Not that we can't sell large premiums, but they're, they're not a popular structure for retail. And given that rates have backed up in here, we're just seeing more and more interest. We're on average doing about a thousand tickets a day at UBS includes their institutional middle market and retail.
(17:52):
And so we have 6,000 financial advisors with over a hundred billion of assets in house. So there's a lot there to service, and these structures are really playing very, very well for them right now. So I would say generally that's what we like in the yield ear space. We do a lot of gas bonds which have backing from financial institutions. We do transportation bonds, episodically, we can do a MT bonds, specialty state tobacco bonds, things like that. And housing bonds have been very popular this year too. It adds a good 50, 60, 70 basis points in spread for that sector. And it's a very high quality sector and that's really appealed to retail. Okay.
Lynne Funk (18:40):
So I think one of the things I think about is retail in times of severe volatility, March, 2020, that sort the herd mentality, the reliable, when things are comfortable, when things are good, what happens when the secondary market space with the great exodus of retail because of whatever reason, the headlines maybe was the great financial crisis, maybe then it was merit with me than news covid or the taper tantrum who fills the void in that space at that point.
Doug Vissicchio (19:08):
So as you mentioned in the beginning of this interview, I've been in the business for over 30 years and I've had the luxury of seeing all of those cycles. It's not that munis can't get cheaper when there's mass outflows and they do get cheaper. The dealer community is taking far less risk now, which had some effect on the market in these periods of volatility. I think the street now owns about 25% of what they used to own pre-financial, great financial crisis. So that's taken some of that out of the market. But we have seen a lot of single strategy hedge funds flourish and really take up that role that dealers now have pulled back from slightly. And so with that advent of these hedge funds, they do fill the void and can provide liquidity when things get stressed. There's also credit funds that will come in when things get really stressed and really dislocated when ratios reach well beyond a hundred percent of treasuries.
(20:27):
There's been enough of not enough. There's been a few of those episodes where these types of funds can step into the market, provide liquidity, and then get that reversion to the mean and munis, which ultimately always happens. And even having been through these cycles enough, even retail now gets a little bit more immune to some of these headlines where the staying power and the stickiness is there and then they will come back into the market when things get cheaper and then start bringing the market back in line. And so yeah, listen, in any market, whether it's corporates or high yield taxables, when things get dislocated, it's hard to stop the freight train, but there's plenty of capital out there. And I also think funds hold more cash on their books now than they have been in the past. And so they can withstand some of these outflow cycles and not be forced sellers into the market, which I think is a very positive thing, a very responsible thing for funds to do so that certainly has helped as well.
Lynne Funk (21:42):
Retail, you've already touched on this, that it has grown, and I think the most recent fed data was that it's grown even more because institutional players have dropped insurers, banks. What's helped the retail market grow for now? How should the muni industry rely on retail going forward?
Doug Vissicchio (22:01):
Yeah, I think over the years from a regulatory standpoint, there's been a lot of great things that have come. It took some time for adjustment, but we've got fair pricing, 15 C two 12 for issuer disclosure. We've got the Emma website for transparency. We have 15 minute reporting that might be going to one minute reporting at some point. And so all of those things help build confidence in the sector and help bring retail in. I think fees have contracted open architecture for firms that provide inventory to their retail now have access to all the offerings up there. I mean, you go on to some of these ECNs, there could be 25,000 offerings up there that gets piped directly into the fas. So there's lots of choices, competitive pricing, lower fees, and open architecture, all of that on top of the regulatory environment has really created, plus there's products like the SMA product, like the ETF product. It provides other avenues for retail to participate in the market with some amount of professional management behind it. All of these have provided that retail liquidity. Retail is the backbone of municipals, right? They make sense for federal taxpayers. And so retail will always be the main driver in this market. And with all of these improvements, it'll only expand over time.
Lynne Funk (23:57):
You mentioned other hedge funds, foreign buyers, what other buyers are out there? The foreign aspect is really interesting. I know as you know, when taxable, that taxable boom in 20 and 21, I kind of got excited myself because it was like harken back to the Babs days, like, oh wow, Munis are going to be very popular abroad and we're going to bring all these new investors into the fold. And then of course great slipped and now taxable issuance is much, much lower. But I guess I'm just curious what other buyers are out there. So
Doug Vissicchio (24:29):
The way I look at it is trying to create depth and breadth just within the retail segment. I think the untapped buyer is in fact retail, even though retail is the main buyer. And we actually at UBS, my team and I created a booklet called Investing in Municipals. I had gone to a conference and was talking with FAS and felt like there could be more education, not only just for retail, but for the fas that are selling it. There's a million different and over 50,000 issuers. It's pretty daunting as a sector. And so creating a education, looking at the benefits, debunking any myths, looking at how credit works, the revenue streams, all of that. I think we live it every day. We live munis every day. And so we know that it's very comfortable for us, but for somebody that's also looking for looking at other choices, alternative products, structured products, equities and taxable fixed income to get people to buy more munis is to educate them.
(25:42):
And so we really try to do a grassroots effort in trying to create that demand at UBS. And so that is definitely one of the areas that I would say we can expand is expanding to the group that it makes most sense for. You brought up Taxables. Taxables is 850 billion of our 4.1 trillion market. It's 20% of our market. And so Babs certainly opened up the world to the municipal product and it certainly is a growing part of it, especially at these yields. We still see traffic from the international community. But again, there it's all about education. Early days for when they started to invest internationally, I was in Europe or in Asia every year educating. And that's what it is about Munis. When you have such a large sector with so many issuers, CUSIPs and nuances to the product, really education is the basis,
Lynne Funk (26:55):
And I think that has to come from, that's what I was going toward. When you think about for the issuers themselves telling their story, even through disclosure being more understanding why perhaps these continuing disclosures are important, because the more information that's out there, perhaps the
Doug Vissicchio (27:11):
More comfort level there is, and then there's more acceptance,
Lynne Funk (27:15):
Particularly when you look even in domestically, the corporate default rate versus the muni default rate is just, it's staggering. It's staggering.
Doug Vissicchio (27:25):
I think the 10 year cumulative default rate, I think there's a munis of Moody's quote is 0.16%
(27:33):
Versus roughly 10 and a half percent for corporates. I mean, that's massive difference. And so 90% of the muni market is a to aaa, 90%, and that distribution is not the same in corporates. It starts, it's more a and down, and we tend to be a and up. And so it does make it a very investible asset class for retail because there can be a comfort level just around knowing you've got essential service bonds with rate setting ability from an issuer standpoint or general obligation bonds, full faith and credit ability to increase taxes, to pay debt service. Those are important things that potentially corporations don't necessarily have that sort of pricing power, if you will, to be able to raise revenue to meet obligations.
Lynne Funk (28:34):
I think one of the things that you always hear from the issuers that perhaps they're getting a little better about is they don't want more disclosure. Obviously, they don't want to have that burden, and it does come at a cost to get that information out there. But I think when you see the benefit of it, particularly when you look abroad, it's such an interesting, I remember there was an issue where I think in Texas, I want to say it was Dallas-Fort Worth airport that made a road show for international investors to explain like Dallas-Fort Worth airport. Think about that. It's a major airport, presumably it's not going to go away.
Doug Vissicchio (29:08):
But even in the competitive space, if we don't have proper disclosure, we won't bid on a deal. And so there's a cost to it if you're not disclosing your financials. And as an investor, it's difficult to invest in something that you don't know what the facts are behind the credit that you're buying,
Lynne Funk (29:27):
And it's not as easy to, you could just look back on American Airlines and see their financials pretty quickly, and it's like, where do you find that? How do you do it?
Doug Vissicchio (29:37):
But we've gotten a lot better, and I think that's why the household segment has grown,
Lynne Funk (29:42):
Probably a testament to the things have been done. So what do you think, if you're looking at perhaps risks, opportunities in this market, what are the biggest risks for communities at this point?
Doug Vissicchio (29:58):
Well, just from a rate standpoint, higher for longer, but I kind of view that as an opportunity higher for longer means the window is open longer and gives people more of an opportunity to invest in this asset class. Certainly you've got geopolitical issues out there which could affect inflation and rates that you need to be thoughtful about tax reform. Sometimes the rhetoric of the tax exemption question comes up on the federal side. I think it's every 10 years or so. Very difficult I think to do, but if there's any threat to tax exemption. But to be honest, if there were, and this is not what I would project would happen, but if for some very small percentage that would happen, everything you own would become exponentially more valuable because it would most likely be a go forward, not a look
Lynne Funk (31:05):
Back, presumably. Yeah, it would be grandfather, presumably. Yeah. This is the thing, right? You learn with what happened with Build America Bonds and why the issuers right now are refunding them is because what one Congress does is never iron plaid. The next one can come in and make changes. And I think that's an interesting thing. It's actually with some of the inflation reduction act, there are direct pay tax credits that issuers are a little like, do we want to go down this again, burning one?
Doug Vissicchio (31:30):
I'm not going to get burned a second time, but this is how we finance our infrastructure. And so this is really important for our country, and it's the way we finance ourselves to build schools and to build roads and to put lights on streets and everything else that municipal bond goes towards issuing. And so having that benefit is really important for the country. And my guess is politicians will see that and do the right thing and make sure that the asset class stays tax exempt. I do think it would be very, very difficult to pass, but
Lynne Funk (32:14):
Strangest things have happened. Yeah. So actually, can you talk a little bit about, you're joining the DVA, what's your role going to be there? Are you able to talk about what kind of the focus there? What's the group looking
Doug Vissicchio (32:25):
To? So I just literally had a couple of conference calls, but I think they are focused on fixed income and focused on municipals. And I think in an election year, Seth obviously has a role there as well, but they are great advocates for the asset class also in terms of structural things like going from 15 minutes to one minute reporting, things like that. So they're an advocacy group that municipals definitely needs out there. And especially on the hill, as things get talked about as things get discussed and laws get passed, that having a group like the BDA be a voice for the municipal segment is really important. So this is new. It's only been the last couple of weeks. So more to come on that. Right.
Lynne Funk (33:28):
When you say have to educate the general public, the retail investor, I think one of the things too is we met many years ago when you were actually at the SMA board. I was a sma. That was the eyeopening experience because to be fair to Congress and to the staffers, they're covering a million different things. So this is just one little area. And so that kind of education, yeah,
Doug Vissicchio (33:51):
We did great. We went to the hill and we met with senators and congressmen and we're able to talk about all the topical events that are going on municipals and try to garner support for the asset class. So like I said, both of these organizations are really important to represent us. Does.
Lynne Funk (34:12):
So what else do you think? Did I miss here? We've covered a lot of ground, but I feel like maybe I missed asking you something important.
Doug Vissicchio (34:21):
Well, I think one of the things, demographic shifts, I think that's one of the things that could affect Munis in different ways. Certainly we see some migrations from higher tax states to lower tax states, some migration down to states like Florida. And so whether it's how much infrastructure that'll be required to support the migration of people or how in some states that they're going to support their infrastructure and their cost basis if they're potentially losing citizens from their areas. So that's just something to think about. I think climate is another very topical thing. Storms, floods, fires, all of that and how that affects municipal credit, and again, looking at each credit on its own and looking at the safeguards that are put up is important for when you're making any investment to make sure that you're aware of the risks. But those would be a couple of spots that would think about.
Lynne Funk (35:40):
No, I agree. I think there's one of the things, particularly with the migration, it's interesting when we're hearing from some buy-side folks about what are you looking at for credit? Like, well, it's not a sector per se, it's a geographic sector within a sector. And that's kind of the interesting, when you mentioned higher ed and
Doug Vissicchio (35:59):
Well, even the way we're designed, we've got regions, right? We've got traders around the country and in different parts of the country because there is a regional element to municipals. And so having boots on the ground and having expertise in those particular areas is really helpful in trading, really helpful in providing ideas to customers and understanding the local politics and the local credits. And so in having 6,000 fas around the country in terms of servicing them, regional offices are really important. And I think it talks to looking at these either whether migration or climate issues, you've got more direct contact without those credit implications.
Lynne Funk (36:55):
So I guess to maybe to sum up, I'll put some words in your mouth and you can correct me if I'm wrong. You're bullish on Munis,
Doug Vissicchio (37:02):
The industry. I'm bullish. I am. I do love munis as it's been my life, but honestly, the window is open. And again, having done this for 30 years and just seeing rates come down for most of that period of time and then all of a sudden seeing 5% coupon bonds behind a four or things like that, or fours at a 4 25, when you start looking at the after tax yield or the taxable equivalent yield, it's incredible. You could take a four and a quarter yield on a bond, and if you're in a high tax state, you're talking behind an 8% on a taxable equivalent basis. A high grade corporate bond is 5.5%.
(37:50):
It's crazy to me that yields are still this high when you make those comparisons. And so the opportunity set is now, it's easy to be bullish in Munis. All the credit points we talked about, the regulatory support, the taxable equivalent yields, everything is just lined up right now. We don't envision a hard landing for the economy soft landing. And then with that, we're estimating a two rate cut this year. As rates start to fall, you can get significant capital appreciation equity like returns in a municipal bond in addition to clipping a tax-free coupon. So it's an incredible product. Obviously we do a lot of business. I think there's a lot more business to do, and my advice is to do it now before it's too late.
Lynne Funk (38:54):
Excellent. Well, Doug, it has been a pleasure having you here. Thank you so much for joining us, and I'm sure we'll be talking more about the work that you're doing at UBS. Thanks for having me. Thank you. Okay. Thank you to everyone for tuning in today. Quick reminder, actually to our viewers, we are heading, the bonfire is heading to Hollywood, Florida on May 6th and seventh for our Southeast Regional Conference. So I hope to see some of you there. We'll be talking about a lot of what we talked about today. So more to come. Thank you everyone.
