Rebuilding America: Muni Mid-Year Update
In January, the Top Five Municipal Market Insights for 2017 were released. Below is a mid-year status on each of the five themes.
1. Innovative Financing Accelerates
We believe Public-Private Partnerships (P3) projects will gain increasing momentum. The faster pace of P3 projects combined with tax credit incentives will align well with the new administration’s infrastructure development agenda. While P3 financing may displace some traditional tax-exempt issuance, we believe the acceptance of P3 projects will be a net positive for additional two-way flow in the municipal market. P3 projects should introduce a multitude of new entrants, including privat equity, developers, and non-traditional buyers to the municipal market. We expect that these entities will be enticed by municipal financing attributes.
Mid-Year Status: Pending
As the administration and Washington, DC work through the agenda, MacKay Municipal Managers believes there will be more clarity and activity related to infrastructure spending in late 2017 and 2018. In the meantime, additional P3 projects continue to be developed in various stages, with over $25 billion of new projects being awarded and expected to begin construction within the next 12-24 months. These projects include I-66 expansion in northern Virginia, LAX Automated People Mover, I-64 Hampton Roads Bridge-Tunnel expansion, new Delta Terminal at LaGuardia, and JFK Airport redevelopment.
2. Liquidity Improves in the Municipal Market
We believe federal regulations and oversight of U.S. banking institutions will ease. As a result, we expect these entities will increase the amount of capital committed to trading activities, including the municipal bond market. However, we anticipate that a greater awareness of liquidity and capital costs will motivate those institutions to show greater preference for bonds rated by at least one rating agency. Therefore, we believe that the liquidity of non-rated municipal bonds will continue to decline.
Mid-Year Status: On Target
In 2017, MacKay Municipal Managers has observed improvement in liquidity, on the margin, for more liquid bonds. An increase in proprietary trading by certain members of the bank/broker dealer community has contributed to this. Stronger retail flows as well as growing interest and capital deployment by non-traditional investors, including foreign buyers have contributed to municipal liquidity. We believe the compelling municipal characteristics and investment profile, relative to other options, are adding to rising interest by non-traditional investors. While the easing of federal regulations and oversight of U.S. banking institutions is in the early stages, there is increased momentum on this topic in Washington, DC.
3. High Tax States Outperform
We believe states with high income tax rates will outperform states with marginal to zero income tax. As federal rates are reduced, we expect municipal investors to become more keenly aware of the benefit of double tax exemption. We believe demand for bonds in high income tax states will be even greater for those fiscally responsible states and local issuers that have maintained their credit strength. Outperformance of states benefiting from population growth momentum and underlying economic stability should protect investors against possible volatility from both legislative and market uncertainty.
Mid-Year Status: Pending
Using California and New York as proxy, their respective sub-indices have performed in close range with the broad municipal index so far this year. Through June 30, 2017, year-to-date performance for the Bloomberg Barclays Municipal Bond Index was 3.57%. At the same time, performance for the California segment of the Bloomberg Barclays Municipal Bond Index was 3.64%, and performance for the New York segment of the Bloomberg Barclays Municipal Bond Index was 3.49%.1
4. Municipals Outperform Treasurys and Lower-Rated Credit Outperforms Investment Grade
We believe municipal to treasury yield ratios will decline during 2017, as tax policy uncertainty subsides. The relative value of municipal bonds, when compared to the taxable market, will move back to more normal historic levels. We expect that this outperformance will provide municipal bond investors with an offset against any negative impact of federal income tax rate reductions. Additionally, spread widening in the fourth quarter of 2016 in the BBB and lower-rated categories offers investors tremendous yield and potential total return opportunities in an uncertain market, where rates will likely be more volatile. Historically, lower-rated, revenue-backed bonds have outperformed general obligation and higher quality bonds in rising rate environments, as underlying fundamentals improve, spreads tighten, and ratings are upgraded.
Mid-Year Status: On Target
As anticipated, municipals have outperformed Treasurys and, as a result, yield ratios have declined as follows:
Yield Ratios – 5, 10, and 30 Year:
- As of January 1, 2017: 93%, 95%, and 99%, respectively.2
- As of June 30, 2017: 72%, 87%, and 98%, respectively.2
Through June 30, 2017, year-to-date performance for the Bloomberg Barclays High Yield Municipal Bond Index was 6.13%, outperforming the Bloomberg Barclays Municipal Bond Index by 256 basis points, which returned 3.57% for the same period.3
5. Alpha Generation from Active Trading and Timely Execution
We believe the uncertainties of new legislation at the federal level will cause swings in perceived value across many sectors, especially healthcare and education. As such, we believe security selection and buy/sell execution will be key to outperforming. In these types of markets, a nimble active management style should be better positioned to generate strong relative performance. Investors employing a buy and hold strategy or investments in funds that have become too large to maneuver effectively will not be able to adequately adjust to the market changes and may underperform in our view.
Mid-Year Status: On Target
We believe there will be great uncertainty regarding all of the policies Washington, DC will implement. For instance, healthcare reform has been resurrected three times now, and will likely experience new iterations. This has caused shifts in the perceived relative value of healthcare bonds since the election, as we have remained active in the space and not content to buy and hold. Volatility in certain credits, such as Illinois and Chicago, is also creating opportunities. Shifting valuation between munis and Treasurys and between municipal investment grade and high yield also creates opportunities to dynamically manage the portfolios for value.
1. Bloomberg Barclays Municipal Bond Index, as of June, 2017.
2. MMD: Thomson Reuters as of January 1, 2017 and June 30, 2017.
3. Bloomberg Barclays High Yield Municipal Bond Index, as of June, 2017.
Active management is the use of a human element, such as a single manager, co-managers or a team of managers, to actively manage a fund’s portfolio. Active management strategies typically have higher fees then passive management.
Alpha measures a fund’s risk-adjusted performance and is expressed as an annualized percentage.
The Bloomberg Barclays Municipal Bond Index is an unmanaged index that includes approximately 15,000 municipal bonds, rated Baa or better by Moody’s, with a maturity of at least two years.
The Bloomberg Barclays High Yield Municipal Bond Index covers the high-yield portion of the USD-denominated, long-term, tax-exempt bond market.
Before You Invest
Mutual funds are subject to market risk and will fluctuate in value.
A portion of a municipal fund’s income may be subject to state and local taxes or the Alternative Minimum Tax. Funds that invest in bonds are subject to interest-rate risk and can lose principal value when interest rates rise. Bonds are also subject to credit risk,
in which the bond issuer may fail to pay interest and principal in a timely manner. High-yield securities (commonly referred to as “junk bonds”) are generally considered speculative because they present a greater risk of loss than higher-quality debt securities
and may be subject to greater price volatility. High-yield municipal bonds may be subject to increased liquidity risk as compared to other high-yield debt securities.
Municipal securities risks include the ability of the issuer to repay the obligation, the relative lack of information about certain issuers, and the possibility of future tax and legislative changes, which could affect the market for and value of municipal securities.
Such uncertainties could cause increased volatility in the municipal securities market and could negatively impact the Fund’s net asset value and/or the distributions paid by the Fund. Securities purchased by the Fund that are liquid at the time of purchase may
subsequently become illiquid due to events relating to the issuer of the securities, market events, economic conditions, or investor perceptions.
Credit Ratings: Standard & Poor’s rates borrowers on a scale from AAA to D. AAA through BBB represent investment grade, while BB through D represent non-investment grade.
Past performance is no guarantee of future results. It is not possible to invest directly in an index.
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This material contains the opinions of the MacKay Municipal Managers™ team of MacKay Shields LLC, but not necessarily those of MacKay Shields LLC. The opinions expressed herein are subject to change without notice. This material is distributed for informational purposes only, and is not intended to constitute the giving of advice or the making of a recommendation. The investments or strategies presented are not appropriate for every investor and do not take into account the investment objectives or financial needs of particular investors. An investor should review with its financial advisors the terms and conditions and risks involved with specific products or services and consider this information in the context of its personal risk tolerance and investment goals. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Any forward looking statements speak only as of the date they are made, and MacKay Shields LLC assumes no duty and does not undertake to update forward looking statements. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Historical evidence does not guarantee future results. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of MacKay Shields LLC.
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