Guggenheim Partners’ managing director Jim Pass oversees the firm’s $8.5 billion municipal sector, which includes research, development and implementation of its strategy for municipal tax-exempt bonds, tax credit obligations, and taxable municipal securities. These include the Guggenheim Build America Managed Duration Trust and Guggenheim Municipal Income funds.
As a veteran with 26 years of experience in munis, Pass talks about investment strategy, political risk, and what he’s seeing in the market.
The Bond Buyer: Tell us a little about the muni funds at Guggenheim.
Jim Pass: At our municipal sector, we manage roughly $8.5 billion worth of municipal assets. And they represent revenue bonds, general obligation bonds, tax-credit bonds. There are various strategies within that.
One is a mutual fund — GIJAX — that was launched in January. We also have a taxable closed-end fund, GBAB — the Guggenheim Build America Bond Managed Trust — that was started in October 2010.
I manage both funds with Scott Minerd and Anne Walsh. And then there is a team in Santa Monica that helps manage those two funds and the other multibillion dollars of muni assets for the firm.
BB: What are your biggest concerns for the municipal market in the near future?
JP: The biggest concern is political risk. It’s about politicians making public policy decisions that have intended and unintended consequences, whether it’s the fiscal cliff or different initiatives. In Michigan, they’re looking at the emergency fiscal manager situation; in Illinois, there’s a referendum regarding how pension payments may need to be supported. It’s policy risk that is the biggest concern. But it’s interesting that the investors, including ourselves, are looking at the real economy, and seeing that there’s consistent growth, and that is trumping the political economy. That’s a positive for the market.
BB: Can you expand upon the meaning of the political economy a bit?
JP: It’s the fiscal cliff and the uncertainty out of Washington, D.C. You can see that there’s been tremendous demand for municipals with the inflows all throughout the year. That’s been able to overcome the negative headlines and the uncertainty as we get closer to the fiscal cliff, and where Washington has to make a decision sooner than later.
BB: What else?
JP: More importantly, we’ve seen issues that may impact, or modify, the tax-exempt market. At the end of the day, investors are looking through that and purchasing bonds.
BB: How did it affect your strategies?
JP: Our purchases are much more in essential revenue bonds and state GOs, where we feel that, based on our bottom-up credit research, we’re very comfortable taking that credit risk.
At Guggenheim, we’re still demanding and focusing on transactions that have structural protections for bondholders, namely us. We’ve seen a return in some cases of poor structures, or covenant-light transactions. And those transactions have been very well-received. In many ways, it really cements that people are looking for yield. And we’re trying to maintain our comprehensive due diligence approach, looking for opportunities that give us spread as well as relative value.
At the same time, we’re making sure that the structural legal protection is there, and that if there is a downturn in the economy, we are protected. And that’s why we focus on the essential revenue bonds, the kind of transactions where we don’t have to worry about political will, and making debt service. So, we stay away from appropriation debt.
BB: What are you noticing about muni credit spreads?
JP: Credit spreads have really come in, based on the sizable inflows. But at the same time, in terms of structural enhancements, there have been more covenant-light deals. So, we’re trying to digest that and stay true to our principles: very focused investment management, looking for credits that can withstand downturns, as well as include legal covenants.
By covenant-light I’m referring to transactions that don’t have debt-service reserve funds, or don’t have mortgages, or use the concept of springing covenants that, if coverage declines, covenants would spring into action. And during the credit crisis, we all learned that it’s even harder to have those covenants spring into action during a downturn.
So, we’ve demonstrated in our strategies, as well as with our assets under management, that we have to really plan for the worst and pick bonds that can withstand good times and bad times. And you don’t have to modify the structure accordingly.
BB: What else can you tell me about your approach?
JP: We’ve always been very reluctant to purchase general fund obligations. Now the rating agencies are beginning to make a much bigger distinction between a general fund obligation and a general obligation bond. Moody’s recently did some downgrades in California looking at that issue. The market is beginning to understand that the willingness to pay is a credit factor.
BB: Which of the developments in California have you been followed closely?
JP: Obviously, we were concerned with the redevelopment language change that basically put an end to the redevelopment authority bonds. Still, we’re comfortable with the ones that we have. But that is an issue that we’re paying close attention to, as well as AB 506 [the municipal bankruptcy bill state lawmakers passed in 2011], the bankruptcy provision, along with the various bankruptcies that have occurred or have been discussed.
BB: Where do you like on the yield curve?
JP: We look for opportunities, whether it’s 10, 20 or 30 years. We’re going to focus on an opportunity, whether it’s a revenue bond or a GO bond that brings value to our clients. And so we’ve been focusing on that 15-to-20-year window. We’ve also recently looked at opportunities where credit spreads have widened to extend a little longer for duration purposes. But in today’s market, you have to be very flexible. And you have to focus on opportunities up and down the curve, rather than just focusing on a portion of the curve.