Brightline knocks high yield funds off track

First Eagle Investments

It's been a bumpy year for high-yield municipal bond funds, especially for those that invested in Brightline passenger train projects in Florida and on the West Coast.

Plummeting bond prices for the Florida rail system particularly derailed First Eagle Investments, which turned in year-to-date worst returns among high-yield muni funds — after nailing the best returns last year.

"It was a choppy year for munis in general, and then when you add in some of the interesting dynamics in the high-yield space with the idiosyncratic credit stories, it did matter what you owned and to what extent," said Tom Murphy, associate director in fixed income strategies at Morningstar.

The Brightline credits, prominent issuers in the high-yield market, have dragged down performance in the space along with other underperforming significant sectors like tobacco, participants said. Political uncertainty, periods of outflows and technical headwinds from record issuance have also pressured the sector.

Year-to-date returns have favored investment-grade funds over high-yield municipals. The Bloomberg Municipal Bond Index year-to-date return is 4.01% while the Bloomberg High Yield Municipal Bond Index has returned 2.45%.

American High-Income Municipal Bond Fund is now the largest among high-yield municipal open-ended funds and exchange-traded funds, with $13.213 billion of assets, edging out the long-time largest fund, Nuveen's High Yield Municipal Bond Fund, with $13.115 billion, according to Morningstar data.

American also notched the best returns, at 4.49% year-to-date, per Morningstar data. Nuveen's high-yield fund returned 2.64%.

Bridge Builder Municipal High Income Bond Fund saw the second-best return, at 4.20%, followed by T. Rowe Price Tax Free High Yield Municipal fund at 4.09%.

In addition to the three funds with returns in the 4% range, six of the largest 15 high-yield funds saw returns in the mid-2% range and five in the mid-3% range. iShares High Yield Muni Active ETF, owned by BlackRock, which is another large Brightline owner, returned 3.55% year-to-date.

The worst return was First Eagle High Yield Municipal Fund, which was -0.25% year-to-date, according to Morningstar data. That marks a big change from January 2025, after its first year, when the fund reported market-beating returns of nearly 12%.

The blame lies with the Brightline credits, which account for five of the top 10 largest positions and make up nearly 10% of the fund, said John Miller, CIO and head of the municipal credit team at First Eagle Investments.

"It's disappointing," Miller said of the returns. "We have a lot of good holdings and trades, and good credit selection in other sectors that in the short term have been overwhelmed by our Brightline holdings."

The Brightline Florida bonds have plummeted in price since July, when the Fortress-backed company announced it would defer an interest payment on a chunk of its debt. Before that, First Eagle was "right in line" in terms of performance, Miller said.

"It's a short measurement period," he said. "And the catalyst is the deferral of the coupon" on the Brightline Florida bonds. "That has triggered some huge markdowns across several major holdings."

A chunk of subordinate Brightline Florida bonds that had been trading at 106 on the dollar since July have dropped to 33 cents, Miller noted. "That right there is the number one reason why we have underperformed in the six-month period."

Miller said he's optimistic that both Brightline projects will stabilize next year and that the First Eagle fund will benefit from rebounding bond prices.

In addition to First Eagle, other large Brightline Florida investors include Nuveen, Invesco, BlackRock and Macquarie. Brightline for years occupied top portfolio positions at Nuveen when the fund was under Miller's control, but the credit is no longer among Nuveen's top 10 positions in its high-yield fund, according to its website.

The Nuveen Short Duration High Yield Municipal Bond Fund remains a top Brightline Florida holder, according to Morningstar. Nuveen did not respond to a request for comment.

Barclays Plc, in a Dec. 3 year-ahead outlook, said the firm had been "a bit too optimistic about the high yield index" heading into 2025 in part because of the Brightline story.

"Although it has benefited from higher carry, it has underperformed this year because of concerns related to Brightline (which represents just under 3% of the index), as well as continued poor performance of MSA tobacco," the bank said, adding that the municipal high yield-investment grade yield differential has increased to 20-month highs. Brightline West's now-completed debt exchange "should substantially reduce the credit's exposure in the index and the possible downside if there is a credit event; moreover, bond prices have already adjusted lower and have limited downside," Barclays said. "In our view, high yield should have a solid 2026."

Muni mutual funds have seen inflows of $25.082 billion year-to-date — $14.97 billion for investment-grade funds and $10.112 billion for high-yield funds, according to LSEG Lipper.

Since mid-September, high-yield mutual funds have seen modest flows, with most weeks seeing smaller inflows. There has only been two week of outflows, with high-yield funds seeing outflows of $80.6 million of outflows for the week ending Nov. 12 and $142.1 million of outflows for the week ending Nov. 19.

There has been a lot of dispersion and bottom-up credit performance this year, particularly at the lowest quality portions of the market, said David Hammer, head of municipal bond portfolio management at PIMCO. That's especially true for many "non-rated issues originally brought to market between 2016 and 2021 when rates were low."

The $5.9 billion PIMCO High Yield Municipal Bond, or PHMIX, returned 3.69% year to date, according to Morningstar. PIMCO held roughly $34 million of Brightline Florida insured bonds and did not hold any uninsured Brightline East or West credits, as of Sept. 30.

"Deals that were done to finance a new project or operating entity, and that were sized based on expectations proved to be very optimistic versus actual asset performance," Hammer said, though he did not comment directly on Brightline.

PIMCO is overweight in several entities across Puerto Rico — such as Puerto Rico COFINA sales tax and PREPA — as well as prepaid gas and other real estate-related risks, including land-backed securities and multifamily housing. The firm is underweight in the lowest-quality segment of the market, particularly in project finance, Hammer said.

The varying returns among the muni market's largest speculative-grade funds, and the volatile performance of "idiosyncratic credits" like Brightline, underscore the importance of investor awareness, said Morningstar's Murphy.

"The experience can be very different based on where you put your money in this category, and it's important for investors to do their due diligence and understand what they're owning," he said.