What does a changing muni market mean?

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WASHINGTON - The municipal market appears to be trending away from its traditional designation as being dominated by individual retail investors, and that may have implications for regulators who place heavy emphasis on retail investor protection.

Data over the past several years show changes both in how much direct retail participation there is in the market and how retail investors are exposed to muni debt. Direct retail participation in the muni market is down, and there is evidence that indirect participation and movement of money to other markets is responsible. But while some market analysts view this is a sign that the municipal market has left its retail-dominated past behind, the market’s primary rules-writing authority continues to place a high emphasis on protecting smaller investors.

George Friedlander, a managing partner at Court Street Group Research, believes that it is “overtime” to stop thinking of the municipal market as a retail-dominated one. Friedlander has authored recent papers pointing out that data from the Federal Reserve shows that the household sector's involvement in the market has come down sharply in recent years. This includes separately managed accounts, in which portfolios of securities are managed for the customer by a financial professional.

“Direct retail and separately managed accounts (SMAs), for the most part, are shown by the Fed to have quite literally collapsed, from $1.673 trillion at the end of 2016 to $1.570 trillion at the end of 2017, a drop of $103 billion,” Friedlander wrote earlier this month.

In an interview with The Bond Buyer this week, Friedlander said he sees several reasons for the change.

“I think one factor more than anything else has been the change in the nature of the retail financial advisor,” Friedlander said, explaining that such professionals once were “securities pickers” for their clients but are now largely more focused on putting together assets for dedicated investment professionals to invest.

He also attributed some of the effect to “rolloff,” saying that investors had been holding a lot of old bonds purchased when rates were higher that were reaching their call and maturity dates over the past few years.

“That money didn’t necessarily get rolled over,” said Friedlander. “In many cases it didn’t.”

“A lot of it went into cash, waiting for higher rates,” he continued, adding, “I think some money moved over to stocks.”

Patrick Luby, a municipal strategist at CreditSights, also cited redemptions as an enormous factor. About $418 billion was called or redeemed in 2017, Luby said, and it takes a lot of work to maintain the same level of exposure when so much debt is coming off the books. Retail likely accounts for a lot of that, Luby said, because institutional investors typically sell their bonds prior to maturity.

The big winners in the changing market are mutual funds and SMAs, Luby said, as retail investors increasingly get their muni exposure through means other than purchasing bonds themselves.

“At the end of the day, it’s still dominated by retail demand,” Luby said of the market. “But a growing portion of that is generated from indirect demand.”

Regulators have made the retail investor a major focus of their fixed income agendas, worried that “Main Street” investors are particularly vulnerable to being taken advantage of or not understanding their investments.

Municipal Securities Rulemaking Board chief market structure officer John Bagley said the MSRB is aware of the trend but that it doesn’t fundamentally alter their calculus because there is no indication that the reduced household participation is a result of reduced faith in the market. The individual investor is still the largest holder of munis, Bagley said, and the MSRB doesn’t think there is a reduced importance of the retail investor.

“For us, it is about education,” Bagley said, and in helping retail investors understand their investment options, whether it is individual bonds, SMAs, mutual funds, or some other vehicle.

“We have spent quite a lot of time on that, and we will continue to do that,” he said.

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