The Bond Buyer: I understand that you’re paying close attention to the coming elections for what they could mean to the municipal market.
Ron Schwartz: Well, the fiscal cliff is a pretty big issue that politicians are going to have to do something about. But definitely, there are fiscal issues coming up that are going to be addressed in the next year. And along with that comes tax reform. And that’s going to affect munis.
BB: What would the fiscal cliff mean to munis?
RS: Well, if nothing is done, we’re going to go into another recession, and that’s pretty much guaranteed. So you’re going to see interest rates go even lower. You might see a 1% on the 10-year Treasury at that point. So, obviously, municipals would go up in price, and it would be okay for fixed income. But it would be very tough on the economy.
BB: Would it make for one big flight-to-quality trade?
RS: There would be a lot of flight to quality, because you’d have to figure that we’re going to go into a recession, so then high-yield bonds would start exploding, and spreads would widen out, even in a lower interest-rate environment. Treasuries would be the best performer. Good-quality munis would perform. High-yield munis would probably get hit, along with taxable high yield.
BB: Do you anticipate that this will be factored into the markets beforehand?
RS: I’d have thought you’d have a little more talk about that now, and maybe a little bit more risk premium in the markets. But it’s not in the markets yet.
BB: Generally, what do you invest in?
RS: It’s usually high-quality, investment-grade paper. We’ve always been known as a higher-quality fund: triple-A, double-A. In the RidgeWorth funds, we don’t make interest-rate bets. Basically, where we have performance is by trading the market, and taking advantage of the inefficiencies in the muni market, because it’s a small market.
BB: Where, in particular, are you looking?
RS: We like essential-service revenue bonds. That’s a good secure sector, so we go into water and sewer bonds, utility bonds. We are selective on GOs. We primarily invest in issues greater than $50 million, or larger, because we want to be able to have timely information updates, to be able to call up and talk to an issuer.
BB: What else?
RS: There are different areas on the curve that are more advantageous. So, we’ll keep the duration card still neutral. But we’ll take the best part of the curve to maximize return.
BB: Where does that seem to be?
RS: The 20-year area, 15 to 20 years. The 20-year area, and then 10 years and it looks fine.
BB: What are you noticing about credit spreads?
RS: At this point in time, credit spreads have narrowed dramatically. We feel like the risk-reward ratio at this point in time is not in higher-yielding municipals, lower-credit yields. If we do go into a recession, you have that issue. How much tighter are they going to really get? They could get a little tighter, but then again, you’re coming late to the party. So, do you really want to stay in there and get that last little bit out of it?
BB: Let’s talk about coupons. Lately, bonds are being issued at a real premium. Is this what issuers think investors want?
RS: With the coupons, yes, we’re definitely seeing different coupon structures. A 3% coupon is more retail-friendly than a 5% coupon. A 5% coupon is more of an institutional coupon, where you look upon it as being more defensive, because a bigger premium bond will hold up better in a bear market than, let’s say, a 3% or a 2% bond. But we are seeing issuers basically saying to retail: here’s a par bond, 3% at par, or 2% at a discount, or something like that.
BB: What are you noticing about issuance these days?
RS: We’re not seeing as much new-money issuance as we might have thought at these low rates. But a lot of municipalities have been fairly fiscally disciplined and they don’t want to add expenses like that. Eventually, they’re going to have to do it; the sewers and the roads have to be fixed.
BB: As you said, it sounds as though the next six months will be a busy time for the muni market.
RS: There’s a lot going on: the elections, the fiscal cliff, tax reform and other stuff. And that’s why we’re seeing more interest in munis, because it’s a conservative investment. No matter what, you’re not going to make a killing, but you’re not going to get killed, either. That’s why it’s not a bad place to hang out, especially in this time period.