For John Donaldson, director of fixed income at Haverford Trust, it's all about analyzing risk and reward — be it on the golf course, in the garden, or in the municipal bond market.
Donaldson, who's watched the muni industry pass through crises dating back to New York City's near bankruptcy in the mid-1970s, said he's helping clients find value during the current tough times by employing the same disciplines and strategies he uses to stay on par on the golf course or cultivate a prize-worthy garden as a member of the Mens Garden Club of Philadelphia.
"It's like course management," Donaldson, a vice president at the Radnor, Pa., firm, said in an interview. "If you know you can't hit the ball 250 yards, you shouldn't try. It's all about knowing what you can and cannot do."
In the current market, Donaldson said he's cultivating a mix of essential service revenue, hospital and higher education, and general obligation debt as part of a larger strategy favoring high-quality bonds with widespread diversification of credit and revenue claims-paying abilities in the intermediate slope of the yield curve.
He uses risk-reward analysis to justify his tax-exempt bond purchases, from choosing the right sector, coupon and maturity, to recognizing the strongest bond covenants and appropriate blend of credit and revenue diversification.
"On the analytical side, you have to ask yourself 'where do I stand and am I getting paid for it?" he said.
By maintaining a duration of four to four and half years, and limiting his exposure to no longer than 15 years, he takes advantage of occasional pricing anomalies with much less of the volatility on the longer end. He feels this technique helps add luster to the $750 million of assets under management he oversees for individual retirees and entrepreneurs aged 50 to 70 — and institutional accounts — that demand capital preservation, income generation, and low volatility.
His average clients' portfolio consists of 70% equities and 30% fixed-income — of which municipals are among the safest and least volatile components.
His bias toward the intermediate range, combined with using the Barclays Municipal 1-10 year Blend Index as a benchmark, helped buffer his clients from one of the market's worst sell-offs in a quarter century and allowed him to take advantage of buying opportunities that further enhanced the value of their investments going forward.
As tax-exempt yields surged nearly 60 basis points over four trading sessions between June 20 and 25, the index returned -1.61% for the month, while Donaldson said the composite return for his portfolios was a weighted -1.64% with a mean return of -0.93%. "We like that Index as a benchmark because it covers everything from 1-12 years," he explained. "That reflects the ability to go slightly longer than 10 years while staying with the defensiveness of intermediate bonds."
Year to date, the index returned -1.26%, compared with the Barclays Municipal Bond Index at -3.76% and the Barclays Long municipal index, which returned -7.06%, Donaldson noted. With a 1.95% yield at the close of trading Monday, he said the Blend Index also performs better than the Barclays Managed Money 1-10 year Index, which closed at a 1.74% on Monday, and had a year to date return of -1.73%.
"With more yield and a better total return for the YTD period, we believe the structure of that Intermediate index achieves the expected mix of defensive characteristics while earning an appropriate yield," he said.
As a result, his clients' portfolios performed "about as expected" with "no undue surprises" through the sell-off. "The move to higher yields made value better, and we are happy to buy higher quality with more yield," Donaldson said. "With a weaker, choppier market we tend to be able to get prices we like. The longer, lower-quality stuff got hit pretty hard."
His focus on the intermediate range also helped keep clients comfortable through an otherwise chaotic episode, he said. "When you don't have long exposure you don't induce panic," he said.
To further enhance the safety of his clients' portfolios, he also maintains an overweight in high-quality paper.
A week ago, he purchased the 2025 maturity from a Franklin County, Ohio, general obligation offering that — although slightly longer than his typical investment — fit his preference for quality and maturity and offered attractive risk-reward compensation.
He bought the natural triple-A-rated 2025 bonds with a 3 ¼% coupon yielding 3.30% versus the shorter 11- or 10-year paper.
"You want the whole portfolio to have control, but we don't want to put a limit on ourselves," he said. By extending to 12 years, Donaldson was able to pick up 20 extra basis points of yield over the 2024 maturity, and 23 basis points compared to the 2023 maturity — without having to extend to the very long end to do so.
"It's a GO for the county that very much fits our discipline of higher quality bonds," Donaldson said.
The bond was also attractive compared to the generic, triple-A GO scale in 2025 that yielded a 3.08% at time of the pricing, according to Municipal Market Data. The 2024 and 2023 MMD benchmarks yielded 2.90% and 2.73%, respectively.
Besides high-quality, Donaldson also favors credit and revenue diversification. He uses GO and essential service bonds, as well as high-grade hospitals and college and university bonds in achieving that balance.
"We strive to construct portfolios that have diversification on sources of revenue rather than simply geographic diversification," he said. For instance, a state like Pennsylvania has hundreds of school districts, whose debt is backed by either state revenues and/or property taxes. Donaldson said owning a basket of these bonds with similar revenue streams would be too homogeneous. "We could put together a portfolio of 50 school district bonds that would look diversified, but would ultimately have a very high correlation," he said.
"We want real diversification on revenue sources so you are not always impacted by economic factors that have a high correlation," he added.
Double-barreled bonds, for instance, are among the strongest vehicles to fit that bill — and are a good substitute in the absence of bond insurance, he said. A bond is considered double-barreled if it has a revenue pledge, such a bonds secured by the revenues of a water and sewer system, which is then additionally supported by a municipality's GO pledge.
"If they are willing to put that on top of it, then it's a strong statement and that's a great structure — it's the exact opposite of a line item in a budget where you don't have a strong promise," he explained.
"As part of our strategy to preserve capital, we spend at least as much time on analyzing the strength of bondholders' claims on the revenue supporting a bond as we do on the credit itself," he continued. Donaldson manages a staff of two other senior portfolio managers and relies on assistance from a research team of five that divides its time between the equity and fixed-income departments.
"Ultimately, any bond is a contract between issuer and bondholder and the strength of that contractual relationship is very important," he said.
Currently, high-quality hospital bonds are among his consistently high performers, including those from large issuers, such as University of Chicago, Duke University, Cleveland Clinic, and Indiana University.
Analyzing 10- and 20-year performance of high-quality hospitals in general, Donaldson has found they outperformed housing bonds by 50 basis points on average, and had a lower loss rate for defaults. In addition, no hospital bonds had defaulted that had a double-A rating at the time of issuance, whereas a third of the defaulted housing bonds he researched had a double-A or triple-A rating at original issuance.
"We find in the high-quality end of the hospital market you are well compensated for the risk," he noted.
Donaldson said he also finds a high level of security in debt issued by municipal bond banks, which consist of borrowing by a pool of smaller municipalities that are unable to access the market on their own because of their size.
"They only borrow what they need, and all projects tend to be really necessary and self-supporting," he said.
He finds less appeal in large deals with wide market exposure. "We think the amount of money basically flat out being wasted or paid out in fees is not necessarily good for bond holders," he said.
Among his other core strategies, Donaldson avoids high-yield paper as well as bonds with large premiums.
"If we recognize the average price is as high as $110, we're not so strident that we'll only buy discounts and below," though it doesn't make sense to sacrifice capital preservation by buying bonds at 115% or 120% of future par value, he said.
Donaldson also steers clear of high-yield bonds. "I have always thought that the high-yield side of munis is even riskier than the high-yield side of corporates," he said. "For something not to have any credit support of any kind has tremendously limited liquidity."
Instead, he implements a risk-control mechanism that involves structuring the highest-quality bonds on the longer end of clients' portfolios, and slightly lower quality, and somewhat riskier paper, on the shorter end. "We avoid having the maximum interest-rate sensitivity and the maximum credit volatility in the same bond," he said.
"We tend to look at things with more yield or more volatility within the shorter maturities — but with controlled risk." The strategy added to the growing comfort level among his conservative clients thtough June's sell-off. "Having longer bonds with higher quality gave us a structural advantage with markets as weak as June," he added.
While he described the recent sell-off as swift and severe, Donaldson can remember turbulent markets in past decades when the market struggled to sell 6% coupons at below 70 cents on the dollar.
"No matter how hard the sell-off was, it can get a lot worse,'' he recalled. Prior to joining Haverford in 2008, Donaldson was a portfolio manager at Penn Mutual Life Insurance in Horsham, Pa.; managing director and portfolio manager at Logan Capital Management in Ardmore, Pa.; and principal and portfolio manager at 1838 Investment Advisors in King of Prussia, Pa.
The financial crisis in New York City in 1975 led to one of the worst markets Donaldson remembers during his career. The then newly created Municipal Assistance Corp. issued its first financing with 11% yields after the crisis, he noted.
Donaldson said the municipal market has managed to overcome major debacles and should continue to do so in the future — despite isolated challenges facing issuers, such as Detroit.
It "had structural problems exacerbated by the very large, severe cyclical problem," he said of the Motor City — the largest in U.S. history to file for bankruptcy. "The state is going to have its finances drained by what it has to do with Detroit, and there could be less state support available within Michigan," he continued. "The strains will be such that the resources will be stressed to meet every need."
Going forward, he intends to remain active in the municipal market and continue to utilize his current strategies to harvest the value that will help their portfolios blossom. "For full tax-paying clients there are few alternatives with taxable equivalent returns" such as municipals, he said.