Muni bond drubbing no surprise, advisers say

Some advisers aren’t surprised to see the municipal bond market getting clobbered.

The rout in municipals “was not unexpected,” said Kenneth Naehu, managing director of fixed income at Bel Air Investment Advisors LLC, which manages more than $6 billion. “It was just a matter of time,” given the large amount of new issues and higher Treasury yields, he said.

Yields have been artificially low since last year, said Greg Ghodsi, founder of 360 Wealth Management Group, who has been moving clients to bonds with terms of less than 10 years.

“It’s been painful,” said Mr. Ghodsi, referring to the low yields he’s had to accept.

Yields on top-rated tax-exempt bonds due in 10 years climbed to a four-month high last week, continuing a rough slide over the past three weeks that has taken many long-term municipal bond funds down about 5% in price.

The market has also seen the highest weekly issuance of municipal debt in at least seven years.

Meanwhile, the Federal Reserve may be losing the fight to keep rates low with its quantitative-easing strategy.

“The uneasiness in the Treasury market is due to the fact that QE2 was not the success [the Federal Reserve] hoped for,” Mr. Naehu said.

“QE2 looks like it hit bottom,” agrees Mr. Ghodsi, who has about $500 million under management,

“In September, we saw the bottom in the 30-year Treasury [yield]” at around 3.3%, Mr. Ghodsi said. But the long yield has risen to 4.32%, “so that’s a pretty significant move from the bottom.”

Higher rates are especially noteworthy in the face of the Fed’s efforts to keep rates low.

“[Last Monday] the Fed bought about $5 billion [in bonds and had] almost six times the number of sellers” it needed, Mr. Naehu said, causing rates to rise.

“The danger is that the Fed … is essentially giving those who want to get out [of bonds] an opportunity” to sell, which is not what the Fed wants, he said.

In the municipal market, Mr. Ghodsi wants to see rates for high-quality long-term bonds go from around 4.75% now, to 5.5% to 6% before he’ll buy longer-dated paper.

“That would be interesting enough for me to jump back in,” he said, given a taxable-equivalent yield of about 10% — equal to the long-term returns from equities.

And higher tax rates would make municipals more valuable, he added.

“If the market continues to back off, we may go back in and put some money to work,” said Mr. Naehu, who’s been out of the municipal market for six months.

But even with prices down, municipal bonds are still “far from attractive,” he said.

The market spookiness has been made worse by the imminent end of the Build America Bond program. After this year, the program ceases unless new legislation extends it.

The program created a “huge demand [for municipal bonds] from taxable-bond funds,” Mr. Ghodsi said.

If the program ends, supplies that have been taken up by mutual funds will need to find retail buyers, he said.

Hedge funds are also out of the market, Mr. Naehu said, “so now we’re back to the individual investor as buyer of choice, and they’re very subject to headline risk.”

More bad news on interest rates and credit quality will come out, he said, “and that will continue to cause more volatility [in the municipal market] than we’ve seen in the last seven or eight years.”
This story was supplemented with reporting from Bloomberg.
E-mail Dan Jamieson at [email protected].

Related Topics: Investment Company Institute (ICI)