Tim Heaney of NewFleet Asset Management is high-quality and neutral duration-minded.
He seeks yield curve, credit, and coupon opportunities by using attractive hospital paper, revenue bonds with strong characteristics, pre-refunded bonds with added liquidity, and benchmarks to measure performance and achieve alpha -- all while limiting credit and interest rate risk and delivering tax efficiency to his conservative clients.
As the senior portfolio manager of municipal securities at NewFleet Asset Management, he oversees $725 million in municipal assets comprised of separately-managed accounts, institutional accounts, and the firm’s own proprietary mutual funds.
He seeks to provide principal protection, attractive taxable-equivalent yields, and tax efficiency to conservative investors who have very little risk tolerance in the current market environment.
“We understand that when investors generally purchase bond funds and [separately-managed accounts], they are making a statement about their risk profile and their desire to avoid paying taxes,” Heaney said this week from his office at the Hartford, Conn.-based firm registered investment advisor and affiliate of Virtus Investment Partners.
“We think the asset class offers reasonably attractive tax-exempt yields,” he said.
On Thursday, the generic, triple-A general obligation scale in 2028 ended at a 2.42% -- or 84.8% of the Treasury yield -- while the 30-year ended at a 2.97% -- 94.5% of the comparable Treasury yield, according to Municipal Market Data.
“When you compare that to other fixed income markets, to achieve that taxable equivalent yield, in many cases, you are moving into low investment-grade or below investment grade securities,” he explained.
“In our strategies we look to be as tax efficient as possible while being careful about the preservation and protection of principle while providing consistent returns,” said the municipal manager, who has 28 years of experience in the industry and joined NewFleet in 2011 after serving as senior vice president and portfolio manager of Virtus Investment Advisors from 2008 to 2011.
NewFleet is a relative value manager that currently provides investment management services to foundations, endowments, corporations, public funds, multi-employer plans, high net worth individuals, and mutual funds.
“The benefits of the tax-exempt market certainly allow investors to utilize the asset class as a foundation” that is sound, secure, and predictable, Heaney said.
In his current role, he specializes in both tax-exempt and taxable municipal bonds, managing a variety of portfolios, including the Virtus Tax-Exempt Bond Fund, which is a national municipal fund; the Virtus California Tax-Exempt Bond Fund, high net worth portfolios, and institutional portfolios.
His overall strategy involves keeping a neutral duration, while identifying changes to the shape of the yield curve to find potential value; evaluating the historical spread relationship between the lower-rated and higher-rate credits; and seeking out coupon opportunities by predominantly investing in 5% coupons that offer more protection in a rising rate environment.
He is also currently monitoring 4% coupons that may present a potential buying opportunity “if there is a continued migration toward higher interest rates and as those bonds approach par and experience potential spread widening associated with tax implications.”
Overall, he feels credit risk spreads are historically tight -- and favors high-quality securities in the current market.
“In many cases we don’t think you are getting paid to take risk with spreads as narrow as they are,” Heaney explained.
As a result, he said many of the firm’s tax-exempt accounts own predominantly double-A and high single-A-rated credits -- a strategy that has been in place over a recent sustained period of tightening spreads.
“We think it’s at a level now where there’s little margin for widening in terms of relative performance,” he said. “We are not taking huge outsized risks, credit quality risks, or duration risks,” he added.
While some high net-worth clients have individual preferences that dictate the risk tolerance in their own portfolios, his overall strategy is consistent across all of NewFleet’s platforms -- from the SMAs to the mutual funds that Heaney oversees.
“In general, our philosophy is more high quality, but that’s not to say we won’t buy lower investment-grade securities,” he added.
Despite the bias toward high-quality and full coupons, Heaney said some portfolios choose to own discount coupons, or different structures depending on their preferences and investment objectives.
“We have an underlying approach, but there’s always an exception to the rule,” he added.
In terms of allocation, he said many clients’ portfolios are overweight revenue bonds versus general obligation credits based on their stronger credit characteristics. At the same time, they also own a higher allocation of pre-refunded bonds, which he said are especially attractive in the current market and are likely to increase in value because of the combination of their shorter maturity and imminent scarcity under the new tax reform.
“In the next year or so, we may lose 50% of pre-refunded bonds,” he said. “That’s not to say there will be no more pre-refunded bonds, but issuers will have to do it on a taxable basis.”
Although he hasn’t been actively adding to that exposure, “we have been the beneficiary of bonds in the portfolio being pre-refunded,” he noted.
“They are the most liquid and when there is significant volatility and less liquidity, pre-refunded bonds always have a strong level of liquidity and benefit from the backing in U.S. Treasuries,” Heaney pointed out.
So far this year, those bonds have performed well and are off to a good start in 2018, according to Heaney.
Besides pre-refunded bonds, he also prefers select hospital credits since they hail from one of the better performing sectors recently.
“We tend to like larger, multi-hospital, and multi-state systems that have a lower percentage of government payors due to the uncertainties in health care, Obama care, and the current administration wanting to change how healthcare is delivered,” Heaney explained.
“Those larger systems with less exposure to government payers will fare well in any environment,” he added.
In general, Heaney selects bonds based on their strong relative value and analysis of the underlying credit fundamentals.
“We may love the coupon and structure, but if it doesn’t pass our credit parameters we don’t add it -- that is paramount to any portfolio,” he explained.
The NewFleet municipal accounts follow benchmark indices as a way to measure risk and performance, and the indices can be chosen to meet a client’s given risk tolerance and investment goals, according to Heaney.
For instance, one individual high net worth investor uses the Merrill Lynch 1-22-year Index as benchmark for his separately-managed account because he seeks to avoid maturity and duration risk while focusing on intermediate securities, while another client uses the Bloomberg-Barclays 1-10-Year Index because he is concerned about principle protection and wants to limit credit as well as interest rate risk.
Meanwhile, the California mutual fund is managed to the Bloomberg-Barclays California Index, and the national fund also follows the Merrill 1-22-Year Index.
“They are guide posts to manage against with the expectation of generating alpha versus these indices,” Heaney said, however, due to compliance restrictions, he declined to disclose any specific performance-related data for the clients’ portfolios or mutual funds.
Although the market has been in a downward interest rate environment for a long time, now that rates are rising, Heaney said he still plans to maintain his high-quality bias throughout any potential volatility.
“We are not reactionary hour by hour,” he said.
The coupon, credit spread and yield curve opportunities he uncovers generally don’t present themselves on a day to day basis, he noted. “We take a longer-term view” of the market -- and build the portfolios over time.
When searching for bonds to add to a client portfolio or the mutual funds, Heaney has found more value and opportunity in the primary market where new issuance is more abundant, but Heaney he will explore the secondary market for incremental yield if it makes sense.
“In a low interest-rate environment everyone is trying to generate as much yield as possible so every little bit matters,” he said.
While the municipal market has experienced a rocky start to February over the last week or so, Heaney suggests that investors avoid being spooked by the day to day volatility and remain faithful to their underlying investment objectives.
Remember, “you have invested in an asset class that protects principle and performs reasonably well with less volatility and provides tax-exempt income -- and the ability to avoid taxes,” he advised.
“There are fewer and fewer opportunities for investors to avoid taxes and munis are still one of them,” Heaney added.