Thornburg Investment Management this month launched a high-yield municipal bond fund seeking to take advantage of distressed prices on what the company claims are fairly stable credits.
The Santa Fe, N.M.-based firm established the Strategic Municipal Income Fund to invest at most half its assets in junk credits.
The timing of the launch is notable. Other than the introduction of a high-yield muni exchange-traded fund at Van Eck Global, the high-yield sector has been decidedly neglected even as munis in general have rallied this year.
Josh Gonze, portfolio manager at Thornburg, said the fund raised about $2.5 million internally and has invested roughly two-thirds of that. The fund is yet to raise significant money from new investors, Gonze said.
The introduction of this product follows an atrocious year for high-yield municipal funds. The sector suffered a negative annual return of 25.1% last year, according to Lipper Inc.
According to AMG Data Services, which tracks money going into and out of mutual funds, investors withdrew roughly $2.8 billion from high-yield muni funds in the fourth quarter. The high-yield muni fund universe shriveled from $54.8 billion in assets at the beginning of 2008 to $31.64 billion at the end.
Gonze said this devastating period for high-yield munis is exactly why now is a good time to buy.
"The idea is to launch the product precisely at the time we can take the capital and deploy it in high-quality assets that are trading very cheaply," Gonze said. "The prices of high-yield bonds collapsed. You want to buy them now because prices are low and yields are extremely high."
In a statement, Thornburg explained that until last year, launching a fund to buy high-yield bonds did not make sense because they were "high yield" in name only.
The spread of a Baa-rated 30-year munis over triple-A rated credits remained below 50 basis points for most of 2005, 2006, and 2007, according to Municipal Market Data. That spread is now at 252 basis points, which is by far the fattest spread in the 15 years of MMD data tracking this relationship.
Gonze said even plenty of single-A credits are trading at wide enough spreads to be considered.
The fund's bonds have an average credit rating of roughly triple-B, Gonze said, which is the lowest investment-grade rating.
"There are plenty of very high-quality bonds rated single-A or triple-B, where the chances of default on the bond are very low and the bond is trading as if it were headed for default," he said.
The maturities in the portfolio are currently mostly 20 years to 30 years, though Gonze said he expects the average maturity eventually to be between 10 years and 20 years.
One example of a bond the fund has bought is a San Antonio gas prepayment issue maturing in 2021, purchased at a yield of 7%.
Jeff Tjornehoj, a fund analyst with Lipper, called the timing of the launch "bold" because the sector was "on the ropes" for much of last year.
He pointed out the sector returned 7% in the first quarter, which could generate interest among some investors with stronger stomach for risk.
"At first you're going to have some of the investors that are less risk-averse and willing to gamble to collect yield making a stab at it," he said.
Gonze acknowledged most investors will want to wait to see the fund establish a track record before investing.
"Which is too bad," he said. "For investors who are willing to act on their insights, they can see that these quality assets are trading at distressed prices and now is the time to buy."
Gonze said he cannot forecast the monthly dividend the fund will pay, though he said he expects it to be at least 100 basis points more than Thornburg's Intermediate Municipal Fund.
That fund paid a 4.2-cent dividend on its Class C shares last month, representing an annualized distribution yield of 4.03%.
The Van Eck high-yield muni ETF, which launched in February, has $76.8 million in assets.