Nuveen's Miller sees muni opportunity after slow first quarter
John Miller, manager of the top-performing fund of its type over the last five years, is seizing an opportunity to add value to the flagship $16 billion Nuveen High Yield Municipal Strategy Fund.
“We have been looking at value through spread and income,” Miller, the head of municipals at Nuveen Asset Management, said in an April 4 interview with The Bond Buyer.
Miller, who oversees more than $140 billion in total municipal assets, is using the current window of opportunity to enhance total return thanks to a combination of rising interest rates, attractive valuations, positive inflows, and improving ratios to Treasurys that have buoyed the market since the start of the second quarter.
“The valuations became more attractive toward the end of the first quarter and rates have stabilized; inflation is low, and defaults are low,” he said.
“We’re tilting a little bit more aggressively on both credit and duration -- but I wouldn’t call it a broad-based shift,” Miller said. He is keeping the overall long-term investment strategies intact for his high-yield fund as well as the $938.2 million California High Yield Municipal Bond Strategy [NCHRX] and related institutional portfolios he lead manages, which total $25 billion.
For example, the high-yield fund he manages is currently structured with 9.65 years of option adjusted duration, which is a bit longer than its S&P Muni Yield Index benchmark and helps maintain performance. The fund seeks out higher-yielding and undervalued bonds to produce enhanced yields and total return.
The institutional shares [NHMRX] have one, three, five, and 10-year average annual returns of 7.87%, 5.29%, 5.76%, 5.50%, as of Mar. 31, according to the Nuveen website, as well as a Securities and Exchange Commission standard 30-day yield of 4.64%. It has a 5.52% average annual total return of 5.52% since inception in 1999.
The shares are ranked second out of 162 funds in the Lipper High Yield Debt Funds category over one year, and hold the top ranking out of 115 funds over five years.
Miller also co-manages the $3.7 billion All-American Municipal Bond Strategy [FAARX] and the $117.2 million Strategic Municipal Opportunities Strategy [NSIOX] and oversees a number of closed-end funds.
“The heaviness of the secondary has cleared up fairly significantly and now valuations are also at their more attractive point,” he said. “The muni to Treasury ratios are elevated almost near 100% in 30 years.”
Interest rates peaked in mid-February and have been mostly stable since then, Miller said.
Volatility in the stock market has contributed to additional interest from investors who want to limit their investment risk with a balanced portfolio approach, he said.
Miller is positive on the high-yield market due to its outperformance for the year to date and is finding pockets of value in select sectors.
High-yield spreads compared with the generic triple-A scale tracked by MMD have narrowed by about 30 basis points, after starting out the year at a spread of 272, which Miller described as “relatively inexpensive.”
The current spread of about 240 basis points means “we are 10 basis points tighter than the long-term historical norm," he said.
“That is going to continue to get tighter and I think that goes to 200 basis points over the course of the year,” he predicted. He pointed to growing demand for yield product and the normalization of default rates, which are now declining after being elevated since 2008, as well as an improvement on Puerto Rico bonds.
“People are looking at ways to pick up more yield without adding too much risk to the overall portfolio,” he said.
Much of the spread compression was the result of narrowing tobacco spreads, the appreciation of Puerto Rico paper -- which is no longer included in the municipal high-yield index -- and the narrowing of health care and industrial development bonds across the board.
Miller uses the Barclays High Yield Muni Bond Index Yield to Worst benchmark compared with the MMD triple-A curve to determine the sector’s attractiveness.
He is uncovering extra yield opportunities by investing in a mix of high-quality and lower-quality credits from troubled states.
For instance, he is currently gleaning nearly 200 basis points or more on state of Illinois general obligation paper, which is the lowest rated among the 50 states as a result of its two-year budget impasse.
Illinois paper is current yielding 4.50% in 2028 and 4.90% in 2048, and trading at spreads of 210 and 197 basis points, respectively, compared with the generic triple-A scale tracked by MMD.
Moody's Investors Service has assigned a Baa3 rating to the state’s planned issuance of $450 million of GO bonds in Series May 2018A and $50 million of GO bonds in Series May 2018B, with a negative outlook.
S&P Global Ratings and Fitch Ratings rate it a BBB-minus.
Despite the budget stalemate, which ended with new legislation in July 2017, Illinois continued to operate on spending mandated by state law or by court orders, ballooning the unpaid bill backlog to a record high $16.675 billion.
Elsewhere in Illinois, Miller is buying revenue bonds on behalf of O’Hare International Airport, and Northwestern University and Northwestern Medical Center.
“The bonds aren’t reliant on the state’s general fund, but the better fundamental names have cheapened just because of the state itself and its reputation, the budget condition, and the state ratings,” Miller said.
Fitch and S&P rate O'Hare's senior lien general airport revenue bonds A, while Moody’s and Kroll Bond Rating Agency rate the airport’s GARBs at A2 and A-plus, respectively.
The non-alternative minimum tax airport bonds in 10 years with a 5% coupon have recently been available at a 45 basis-point spread to the generic triple-A market.
Outside of Illinois, he is active in the high-yield market -- including the tobacco, health care, community development and land-secured sectors -- where yield spreads have recently ranged from 254 to 228 year to date, compared to the triple-A scale, according to Miller.
While he declined to comment on his potential participation in this month's $3.2 billion New Jersey tobacco deal, he said his high-yield fund is a prominent holder of the existing bonds that were slated to be called.
“We are trying to maintain our tobacco weight in an environment where tobacco bonds are getting called fairly aggressively,” he said. The deal’s 2046 maturity, which was triple-B rated, was priced with a 5% coupon to yield 4.90% -- nearly 200 basis points cheaper than the generic triple-A GO bond in 2048 on April 6 at the time of pricing, according to MMD.
Sticking to his strategy
Miller is reaping the rewards of widening spreads in the high-grade market and looking beyond his bias toward 5% coupons.
Instead, he is taking advantage of the additional yield pickup of approximately 25 to 40 basis points available by buying 4% coupon paper in the current market, he said.
Overall, he is maintaining his long-term investment strategy.
“I wouldn’t say we are making any major strategic shifts based on short-term moves” in the market quarter by quarter, he said.
Miller attributes the overall performance of the high yield and other funds he oversees to strong analysis and teamwork.
"At the heart of our municipal bond team is fundamental credit analysis," Miller said. "We are fortunate to draw upon the deep and seasoned expertise of our research analysts to help in constructing our portfolios. They are an indispensable part of that process."
Other market improvements are keeping him active in the second quarter.
“Our cash inflow has been steady and we have found that we look constantly for opportunities in the primary and secondary market,” he explained. “We have been carrying some cash -- but we have lower cash balances as we get opportunities to put that money to work,” he said.
“The secondary market has actually been presenting more opportunities than the primary on a year-to-date basis, and I think that’s going to continue to be the case,” Miller said.
Flows and demand are expected to continue to exceed the number of bonds being sold, following a glut of issuance in December ahead of the new tax law, Miller said.
Forecasting future opportunity
Looking ahead, Miller is positioning his portfolios based on a forecast for a trading range on U.S Treasurys between 3% and 3.25% over the course of 2018.
“I think that munis at a 100% ratio should be able to outperform that yield forecast, and that’s based on lower supply, higher demand, and stable credit quality,” Miller said.
Investors worried about rising interest rates should look at it as a window of opportunity and not a concern, Miller advised.
“The biggest fear among muni investors this year has been about interest rates,” he said. Investors should remember that returns are generated by income, and when interest rates are priced higher, more income can be produced, creating a better opportunity to invest.
“It’s a constant concern, but a little misplaced,” Miller said. “The focus should be on income generation, since income and total return are tightly correlated.”
He also suggests that investors think about income and be mindful of inflation data. However, he said inflation has been “pretty tame” recently, as it has only increased by 1/10 of 1%.
“There’s a huge hype about inflation and yet inflation remains below 2%,” Miller said. “With the Fed tightening before inflation hits 2%, they are getting ahead of any major move in inflation.”
Miller said investors should reap rewards from continued fundamental improvements, such as market stability.
“As the financial markets have in general become more volatile based on politics and equity volatility, munis have not been correlated to that at all, and that helps stabilize the overall portfolios," Miller said.
For instance, from a valuation standpoint, triple-A municipal bond yields are almost exactly the same as a year ago, Miller said. On April 11, the generic triple-A GO in 2048 yielded a 2.93%, compared with 2.94% on the same day a year ago, according to MMD municipal curve data.
Overall, he said, the market is in better shape.
“While yields are coincidentally almost exactly the same as a year ago, the outlook for the next three quarters is actually better based on performance potential and the certainty around key metrics,” such as tax reform legislation, Miller said.
“We have removed the uncertainty of tax reform, which a year ago was just being debated with all the scenarios that could have unfolded," he said. “Based on what the Fed has done, there is more yield available for short defensive bonds,” such as limited-term mutual funds yielding 2%, for example.
That should be advantageous for conservative investors who are sitting on the sidelines, especially if they want to limit their interest rate exposure. “You can receive between 1% and 2% tax-exempt income with the ultra low risk profile,” he said.
“You have the constant worries about the Fed raising rates too much, and about how long the rate increase cycle will last, and how long will the curve be flattening,” Miller said.
“There are the ever-present risks in the fixed income markets that are both rate and credit related,” he said, “but I think those have been well priced in.”