PGIM's Courtney sees smoother ride ahead for munis
Susan Courtney, head of municipal bonds at PGIM Fixed Income, is hoping to find opportunities ahead as a result of technically favorable market forecasts for net negative supply, stability in interest rates, and positive fund flows.
“The tone has improved with the stability in rates since the end of February, and we are getting past the weaker technicals related to tax time,” the managing director at the global fixed income asset management firm told The Bond Buyer in an April 13 interview. ”The net negative supply forecasted provides a supportive tone from a technical perspective.”
Courtney, who oversees the management of $23 billion in total municipal assets as of Dec. 31, is driven to find value in the current municipal market through a combination of high-grade and high-yield opportunities.
PGIM Fixed Income, which oversees $709 billion in total assets as of Dec. 31 and has locations in Newark, London, Tokyo, and Singapore, is a unit of registered investment advisor PGIM Inc., both Prudential Financial companies.
The firm’s municipal bond department headed by Courtney manages approximately $2 billion in four retail mutual funds, including the Prudential National Municipal Bond Fund, the Prudential California Municipal Income Fund, the Prudential Short-Duration Municipal High Income Fund, and the Prudential Municipal High Income Fund. The group manages another $5 billion in tax-exempt proprietary accounts, among other municipal assets.
Courtney said spreads are attractive in the tobacco sector, in lower-rated hospital credits, and charter school bonds.
Triple-B and double-B rated hospital credits, for instance, have recently been available at a spread of 140 basis points versus the long generic triple A general obligation scale, while double-B-rated charter school bonds were recently available at a spread of 197 basis points, she said.
Though both spreads tightened by between 20 and 30 basis points as of April 13, according to Courtney, they were still attractive, given that the triple-A GO scale in 2048 yielded 3.02% as of April 20, according to MMD.
In addition, Courtney said she is on the lookout for tobacco bonds that have equally-attractive spreads and offer value -- especially considering so many were subject to redemptions.
The Short Duration fund owns 16.5% exposure to healthcare credits and 5.7% exposure to tobacco debt, while the Municipal High Income fund owns 20.2% in healthcare debt and 9.7% in tobacco bonds, according to the firm’s website.
“As more and more tobacco deals are getting refunded, we are losing an amount of true high-yield credits,” Courtney said.
“Given the headlines in the muni space," she said, "I think there’s another reason to justify being in a diversified portfolio versus putting all your eggs in one basket.”
The objective of PGIM’s Municipal High Income and Short Duration High Income portfolios is to maximize tax-exempt income and produce strong performance versus the benchmark relative to the peer group.
The high-income portfolios include a combination of high-grade paper and high-yield paper, which supports Courtney’s perspective on diversification.
Triple-B paper represents the highest exposure in the Municipal High Income Fund at 32.1%, followed by 20.9% in single A paper, and 12.6% in nonrated securities. It also holds 6.5% in triple-A credits and 7.6% in double-A paper, according to the firm’s website. That fund follows the 50/50 High-Grade/High-Yield Bloomberg Barclays Index.
The Short Duration Municipal High Income Fund, which manages to the Bloomberg Barclays 50/50 High-Grade/High-Yield 1-8 Year Index, owns 30.7% in triple-B rated paper, followed by 27.4% in single-A debt. It also holds 15.5% in double-A bonds and 1.9% in triple-A paper, according to the website.
Both high-income funds gain income and total return from being historically overweight in triple-B paper and underweight in non-rated securities, which have been pre-refunded or matured in recent years.
The national and California funds, are overweight in single-A and triple-B bonds and underweight in double-A and triple-A paper relative to their benchmarks. The National Municipal Bond Fund follows the Bloomberg Barclays Main High-Grade Index, while the California Municipal Income fund manages to the California Index within the Bloomberg Barclays Main High-Grade Index.
Revenue bonds have traditionally provided more yield than GO bonds, though the tide has been turning in recent years, in Courtney’s view.
“Historically, in terms of sector positioning we are overweight revenue and underweight GO,” she said. “With GOs, there is typically less incremental spread. but that has changed in recent years with multiple downgrades and spread widening.”
“We have seen an opportunity in the last year or two to add to exposure in the GO space,” she added.
One recent example is the Illinois GO credit, which is currently on her radar screen. Courtney said the bid-side for the state’s GOs has widened by about 25 basis points in five years and by 50 basis points in 10 years, even though certain maturities and structures have tightened versus MMD’s generic triple-A GO scale since last June amid the state’s fiscal and budget debacle.
She favors the Illinois GOs, for example, versus small, nonrated or lower-rated offerings with less liquidity, such as small private colleges or universities, which she usually avoids.
Among regional state credits, the Municipal High Income Fund has 11.5% exposure to Illinois paper, followed by California and Texas, in addition to 7.4% of GO bonds, according to the firm’s website. The Short Duration Municipal Income Fund holds 21% in Illinois paper, followed by 10.5% in Texas, and 7.3% in Florida. It holds 10% in GO paper.
Looking in the rearview mirror, the fourth quarter brought a rate back up that sparked an opportunity for many investors as well as record supply in December, followed by a lack of volume, yet strong fund flows in January, Courtney recalled.
“In January, the heavier dealer inventories and back-up in rates weighed on the market,” she said.
With the forecast of net negative supply for the summer months, the municipal market may be poised for a continuation of recently improved market conditions, Courtney said.
“If the market is in a stable rate environment, that should be positive for fund flows,” she said. With the 10-year Treasury yield at 2.87%. which is closer to the high end of the range, she said, mutual funds may see decent demand going forward.