Is this the buying opportunity retail has been waiting for?
Encouraged by the recent uptick in municipal bond yields, retail investors are getting more active, searching for new bonds and looking to reinvest any remaining rollover proceeds. While some are coming up empty-handed due to the summer supply slump and relatively low absolute yields, it’s certainly not for lack of trying, municipal experts said.
Mom and pop investors are looking to spend cash — either on plain-vanilla paper in the high-quality market, or exploring yield-ier opportunities by extending their duration or sacrificing quality — but are finding it challenging.
“We are seeing our investors trying to be as active as they can in the primary and secondary markets,” said Tom Kozlik, director and municipal credit analyst at Janney Montgomery Scott. “They have been operating at a high pace of activity because there is a strong relative-value argument to be made for municipals.”
For instance, on Aug. 20, the 10-year triple-A municipal bond was yielding 103.3% of the 10-year Treasury yield, while the 30-year municipal was yielding 102.7% of its taxable counterpart, according to Municipal Market Data.
But, Kozlik said, “the low-rate environment and lack of supply remain barriers on a trade-by-trade basis.”
Despite the mammoth short-term deals that have priced recently, including $10 billion of California revenue anticipation notes, the long-term market has faced a typical seasonal lull.
Rick Calhoun, first vice president of retail sales at Crews & Associates, agreed that retail investors continue to be active yet selective, but that finding value is tough due to the relatively low rates and supply.
However, lately, the recent weakness is stimulating retail demand and helping investors implement a mixed range of strategies — when and if supply is available, professionals noted.
Yields started backing up from their recent lows about three weeks ago. On Aug. 20, the 30-year triple-A yield curve ended at 3.01% for the third consecutive session. That was up six basis points from the previous week when the 30-year ended at a 2.95% on Aug. 14, which was up three basis points from the previous session. Overall, the 30-year muni has increased 22 basis points in the past three weeks on the heels of a strong rally in July.
“We have seen over the past few trading sessions some higher yields related to a better economic outlook, so that in itself could create additional volatility,” said Peter Hayes, managing director at BlackRock Inc. “However, yields have fallen very far this summer, so any backup would ultimately be healthy and create value for investors.”
At Miller Tabak Asset Management, retail investors are being driven to reallocate money to municipals as opportunities arise — but they are staying relatively conservative, said chief executive officer Michael Pietronico.
“High-net-worth clients have shown increased interest of late as yields have ticked higher,” he said. In addition, investors have been interested in putting available cash back to work in tax-exempt munis in anticipation of higher taxes.
“The overall backdrop of the search for income has added an additional element to demand,” Hayes agreed. He said retail investors over the last two months have lived up to their reputation of being dominant buyers of municipal securities. “This summer, it seems as if this has been even more apparent,” he said.
But experts said not all retail buyers are reaching for individual bonds. Many investors prefer to leave the decision-making, portfolio analysis and risk management to the professionals.
“Retail demand for direct purchases seemed to have gone on strike after the last run-up, which was a bit too far, too fast,” said Peter Delahunt, national institutional sales manager at Raymond James & Associates Inc.
Delahunt and Hayes said retail investors opted to pour money into municipal mutual funds.
“Flows into open-end municipal mutual funds have exceeded [$1 billion] per week, according to [the Investment Company Institute], for the last several weeks, as more investors turn to managed solutions rather than buying individual bonds,” Hayes said.
“The evidence in terms of strong mutual fund inflows tends to support the notion that they are putting the money to work,” he said. “Income is important to many of these investors, and with cash paying near zero interest, the need for income drives the decision to reinvest quickly.”
The professionally managed alternative to owning individual bonds, Hayes said, helps allay retail investors’ concerns over finding bonds, understanding credit and replacing called bonds, especially on the heels of the year’s massive refunding volume.
Overall, he has observed a trend toward income generation, “either through longer duration, as evidenced by flows into long-term and intermediate bond funds, as well as by migrating down the credit curve, as can be seen from strong flows each week into high yield municipal funds.”
Calhoun of Crews & Associates said while most of the firm’s retail clients are sticking with investment-grade securities, some are venturing beyond the norm.
“We have seen a shift toward larger coupons,” he said. “As one trader put it, ‘110 is now the new par.’ Customers are also moving out longer on the curve for more income and some investors have lowered their rating standards in order to pick up a little more income.”
At Janney Montgomery, Kozlik said retail investors are active across the board — and are also willing to take a little risk for reward.
“A limited number of retail investors are mindful of the direction of interest rates and want to keep their money in short maturities, but the low yields in those spots make it difficult,” he said.
As a result, some investors are moving out on the credit curve for yield, when and if it’s appropriate for their investment strategy, he said.
“Sometimes this means that investors who were in high-grade GOs move out to capture additional yield with high-quality revenue bonds,” Kozlik said. “And sometimes when they move further out on the credit curve, it means investors look at a high-yielding sector, such as health care.”
Meanwhile, back at Miller Tabak, Pietronico said new money from clients of late “might reflect a more conservative bias by investors.”
“From our perspective, clients are more concerned about preservation of capital, and as such they are not reaching down the credit curve for yield,” he said.
“Sophisticated investors understand that 4% coupons represent value in this market, as the extra spread these bonds offer is a compelling value, considering the Federal Reserve is quite far from raising rates,” Pietronico added.
Experts said retail participation could hinge on how the market reacts to any volatility unfolding in the fourth quarter.
“The election will create some noise as speculation grows over who will control Washington and what agendas may ultimately get pushed through in 2013,” Hayes said, referring to the upcoming presidential election.
“An entire new set of potential concerns are on the horizon with the near-term fiscal performance of the U.S. economy, the potential effect of Europe, the November elections and the fiscal cliff all barreling down on investors pretty fast,” he said.
Potential tax reform and lower federal spending are also on the list, he added.
Calhoun agreed. “The presidential election is on everyone’s mind because of how a change in leadership could impact U.S. fiscal policy,” he said.