Tag: Municipal Fixed Income

Five Questions to Ask your Municipal Bond Manager

Posted on by Sage Advisory

by Jeffrey Timlin

  1. At current valuations, should I wait to invest cash in the municipal market?

All things being equal, history has shown that bonds outperform cash over most time periods. Although municipal valuations are not super attractive right now, every asset class is rich and trading at or near their all-time highs. The benefit of municipal bonds is not only tax-free income, but as an asset class, it is negatively correlated to the broad market during market downturns. If equities enter a corrective phase, municipal bonds typically hold up well and may even experience modest price appreciation.

 

  1. When will the strong technical environment normalize?

To be sure, the record municipal cash inflows experienced year-to-date cannot last forever. The caveat to that remains the ongoing reduction in new issue supply, as well as the elevated levels of maturity and coupon payments coming due. Historically, periods of significant outflows have coincided with negative returns as investors and funds alike were forced to liquidate positions to raise cash. Unlike those periods, the current environment shows mutual funds sitting on higher levels of cash and they are cushioned by higher levels of maturity and coupon roll-off. Lastly, as a result of the decade-long recovery, a record number of millionaires now reside in the U.S. – more than 11 million people. These millionaires benefit fully from the tax-exempt income offered by municipal bonds, especially the ones who live in high-tax states.

 

  1. Are there any credit issues that I should be concerned with?

Overall, there are no serious credit concerns within the municipal market. Several well-known credits, such as the State of Illinois, City of Chicago, and Puerto Rico remain challenged and should be reviewed on a quarterly basis. Although mid-to-long-term issues do exist regarding pension and health care funding levels, there is not cause for immediate concern. Due to the monopolistic characteristics and taxation powers inherent in most municipal issuers, the municipal market remains one of the safest areas within the fixed income markets.

 

  1. I am worried about losing money in fixed income. What can I do to protect myself?

Many investors overestimate the downside risk of municipal bonds. Over the past 15 years, a core municipal strategy that has an effective duration of approximately six years and invests in maturities out to 30 years only had two negative-return years: 2008 (-2.49%) and 2013 (-2.55%). Even on a quarterly basis, the worst return during that time was -4.17% in the fourth quarter of 2010, after Meredith Whitney’s bogus municipal default prediction. To put that into perspective, the worst quarterly return for municipal bonds has occurred to daily returns in the equity markets on a fairly consistent basis. For investors looking to minimize downside risk, municipal strategies with a duration of four years or less tend to offer an attractive yield, while limiting principal loss on a yearly basis.

 

  1. Why does it take a few weeks to get my portfolio fully invested?

Municipal portfolio cash could be invested in a day or two, provided the investor is not concerned with valuations or optimizing their sector and credit profile. Unlike equities, which are constantly available, municipal bond supply ebbs and flows daily. A bond that trades today may never trade again if held by buy-and-hold investors. In addition, Sage is a value-based investor that screens the market for attractive offerings. A combination of new issue, secondary offerings, and bid wanted are utilized to source bonds at attractive levels. Each of these avenues opens and closes daily and takes time to access. Sage believes that having the patience to wait a few weeks to purchase the most attractive offering will pay dividends in the long run.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Trust Accounts Benefit from Tax-Exempt Income

Posted on by Sage Advisory

by Jeffrey Timlin

Unlike the graduated federal income tax brackets that max out at 37% with taxable income at $500k or more, trust accounts benefit from owning municipal bonds at a significantly lower tax bracket. As the political and economic environment becomes increasingly uncertain, many high-net-worth clients are turning to trusts to protect their assets as well as provide a tax-efficient way to transfer assets to family members. In 2012, the American Taxpayer Relief Act (ATRA) added new net investment income tax (NIIT) brackets for certain trusts as shown in the tax table below.

 

Source: IRS.gov

 

For clients in non-grantor trusts, the benefit of owning municipal bonds is realized almost immediately since the maximum income bracket tops out at only $12,500. As an added benefit, by utilizing tax-exempt municipal bonds to produce income, the trust’s beneficiary could also avoid paying the 3.8% investment income tax associated with the Affordable Care Act of 2010 for a maximum tax savings of 40.8%. Depending on the state of residence, an allocation to in-state municipal bonds may further enhance the tax-efficiency of the income generated within the trust.

Since the inception of municipal bonds, high-net-worth individuals have successfully utilized the benefits of tax-exempt income. Along with tax-free income, investors have benefited from a high degree of principle protection and low levels of price volatility. To ensure the proper use of municipal bonds within a trust, please review the trust agreement with your financial advisor, tax accountant, and trust attorney. Once approved, allocating to municipal bonds could significantly reduce your annual tax liability.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

 

Rising Taxes and Out-Migration Trends: A Bad Budgetary Combo

Posted on by Sage Advisory

by Jeffrey Timlin

Numerous major metropolitan cities have experienced an economic boom over the past decade as the technology, energy, health care, and financial industries have flourished. Although their fiscal outlook has improved dramatically since the Great Recession, municipalities face several challenges. An influx of highly paid employees has been a double-edged sword. Tax revenue has increased but so has the cost of living, which has decreased affordability for public service workers. Raising taxes to pay higher salaries for public service workers is only a short-term solution, as municipalities will eventually have to grapple with their main source of revenue – wealthy taxpayers – moving to less-taxing states.

Politicians have been talking about the wealth gap for decades yet have done little to fix the real issue. In this case, the benefits of economic success are being offset by the challenges associated with providing enough public services. That may seem counterintuitive since with more revenue generated comes greater funding ability. However, public services are often the largest municipal expenditure, and the public employees providing these services – teachers, firefighters, police – require an adequate salary to afford to live in the areas they serve. The additional revenue received from high-income tax payers has not been enough to support necessary salary and benefit increases to support the increased cost of living for public service employees. (It is important to note that salaries and benefits for public employees are fixed and don’t fluctuate in-line with tax revenue.) Just look at the defaults of Puerto Rico, Detroit, and Vallejo.

 

 

Although the top 10 cities listed above are currently rated AA or better, the growing economic strain associated with the need for additional public services remains unsustainable and will eventually bring greater downward pressure on their respective credit ratings.

A good example of this challenge is found in not only New York City but, more importantly, in New York State, which recently announced a projected $2.3 billion budget deficit. According to New York State officials, this is the most serious revenue shock the state has faced in many years and it is expected to worsen before it gets better. Fiscal imbalances of this nature and magnitude are becoming more common among those cities and states with exceedingly high tax burdens. Indeed, according to a recent WalletHub survey that looked at the combined state income, property and sales tax burdens paid by citizens, New York came in first, at 13.04%; with Illinois, New Jersey, and California close behind.

Ongoing political pressure to resolve these challenges will undoubtedly lead to an increase in tax rates, primarily on the wealthy. Although this may initially seem appropriate and prudent, the high reliance on high-net-worth residents can be fickle. Unfortunately, voters and politicians severely discount the ability of wealthy individuals to relocate to friendlier tax environments. For example, growing tax burdens have become a force for significant out-migration from the Northeast and California to places like Florida and Texas. According the 42nd Annual National Movers study by United Van Lines, last year 61.5% of New York residents left the state, while just 38.5% moved there. More importantly, of those who left, 41% earned $150,000 or more and only 8.4% earned less than $50,000. It is also worth noting that New York City, a traditional magnet for the young and talented, saw the biggest loss of millennials last year compared to other large cities, with more than 29,000 residents moving elsewhere.

Although no major municipality has experienced a sudden outflow of wealthy residents, a slow but steady outflow has a cumulative effect on budgets. This is showing up in places like New York, which from 2010 to 2017 suffered a net out-migration of over 1 million taxpayers, a level that was more than any other state, including California, which lost just under 1 million taxpayers over the same period. This apparent secular out-migration trend is particularly troubling because the top 1% of New York State earners pay 46% of all the income taxes collected by the state.

 

 

As states like New York, New Jersey, Connecticut, Illinois, California, and the major cities within them, become more dependent on an increasingly smaller number of high-income taxpayers to fund their growing fiscal deficits, the ongoing leakage of these outbound taxpayers can and will cause significant budget disruptions for the municipalities and their respective creditors.

We believe that these trends, if left unresolved through significant budget expense adjustments, will become increasingly difficult for creditors and credit ratings agencies to ignore. An eroding tax base is difficult for most municipal governments to curtail once trends such as those cited above get firmly underway. Adding to our concern about these trends is the recognition that the U.S. economy continues to enjoy a robust level of economic activity. Until now this has allowed many state and city governments to defer any meaningful spending adjustments, and they have preferred to raise income taxes to punitive levels in order to close short-run funding gaps. At some point, the current favorable environment will dissipate and disappoint. That is the day of reckoning that creditors should be concerned about in the months ahead.

As always, the determining factor for investors looking to make allocations to municipal bonds remains valuations. In the current environment, our view is that many of these tax burdensome issuers do not provide enough yield reward relative to municipal issuers from other regions or possibly taxable corporate bonds with similar credit profiles, unless you are a resident of the high tax rate state. Fortunately for our clients and investors in general, the municipal market provides numerous beneficial alternatives to enhance yield reward and maintain a stable credit profile while avoiding some of the potentially harmful secular demographic trends presented above.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

 

Now is the Time to Reduce BBB Credit Risk to Protect Against Principle Loss

Posted on by Sage Advisory

by Jeffrey Timlin

Due to an extremely strong technical environment, municipal yields have experienced a significant decline from the highs of 2018. In addition, credit spreads have tightened to historic lows and offer limited income reward relative to the risk of principal loss. A powerful portfolio management tool that Sage utilizes to optimize risk and reward characteristics is spread valuation analysis. In a historically wide spread environment, Sage would be allocating a larger percentage of the portfolio to lower-rated credits, due to the advantageous income environment. Alternatively, when spreads are near their historic low, Sage will reduce exposure to lower-rated credits to lock in positive returns as well as protect against principal loss.

As show in the chart, the additional spread that municipal investors are offered for owning BBB-rated bonds over Single A-rated bonds is currently 70 bps. Although this may seem attractive from a yield/income perspective, the probability of principle loss remains elevated.

 

Source: Bloomberg

 

As an example, let’s take a generic BBB-rated bond with a five-year maturity, a 5.00% coupon and a four-year duration. If BBB spreads quickly revert to the 94-basis point average (shown in gray), the principle loss relative to a comparable A-rated bond would almost be 1.00%. However, if BBB bonds trade back towards the upper end of their historic range (127 bps shown in red), the principle loss under this scenario would be approximately 2.25%. For an investor looking to reduce credit risk and who can accept a slight-to-modest reduction in income, reducing exposure to BBB bonds and swapping into higher-rated credits seems like an advantageous tactical trade until the technical environment normalizes.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

A Reason to Love the MTA

Posted on by Sage Advisory

Due in part to ongoing fiscal challenges, New York’s Metropolitan Transportation Authority (MTA) bonds are currently trading at attractive levels. At 55 bps over comparable AAA bonds, 10-year MTA bonds rated A1 by Moody’s offers investors an opportunity to pick up some additional yield without significant credit risk.

As one the oldest and largest transportation networks in the U.S., the authority remains a vital part of New York’s infrastructure and an essential component of commuting for New York, New Jersey, and Connecticut residents. Despite structural deficiencies, Governor Andrew Cuomo, Mayor Bill de Blasio, and many other local leaders are heavily invested in the ongoing success of the MTA. A recent 10-Point Plan to transform and fund the MTA has significant support from both parties. For those who can handle modest credit risk and a bit of spread volatility, MTA bonds offer a good entry point.

As shown below, by selling out of 10 Yr AAA Georgia State GOs (cusip 373385CN) at a 2.17% yield and purchasing 10 Yr A1 MTAs (cusip 59261APZ) at a 2.72% yield, an investor can capture 55 bps of additional income with the same duration/interest rate risk.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

The Four Seasons of Muni Bond Investing

Posted on by Sage Advisory

Timing is everything. For a municipal bond investor, annual seasonal trends can provide great entry and exit points, if executed properly. There are four distinct seasonal periods that occur annually due to structural factors inherent in the municipal bond market. If timed correctly, municipal investors can increase their probability of successfully trading these markets and reap the reward of better returns.

The four seasonal periods that affect the municipal market on an annual basis are January Reinvestment, Tax Season, June/July Redemptions, and the Holiday Season Slowdown.

January Reinvestment

Although not the heaviest period of bond maturity and coupon payments, January 1st does experience an elevated level of cash that needs to be reinvested. In addition, the lingering effects of the Holiday Season Slowdown contribute to a limited amount of new issue supply, as well as diminished levels of secondary supply offered by broker/dealers. This strong technical environment tends to last anywhere from a few weeks to well into February, depending on the direction and magnitude of market flows. For investors who can time liquidity needs, January represents one of the most advantageous times of year to raise funds.

Tax Season – late March through April

From late March until the end of April, the municipal bond market tends to see both a reduction in demand as well as a heightened level of selling to fund tax payments. (Selling tax-exempt municipal bonds to fund personal federal and state tax liabilities remains one of life’s great mysteries.) Regardless, tax season provides an attractive entry point for investors, as limited demand and improving new issue supply tend to push valuations to more attractive levels.

June/July Redemptions

The heaviest period of maturing bonds and coupon payments is during these two months and represents anywhere from 40% to 60% of annual redemptions. Typically, municipal issuers come to market during this time, which offsets the demand pressure from reinvestment. Unfortunately, over the past several years, municipalities have been paying down debt and reducing debt issuance, which has created a net negative supply environment. As long as new issuance remains below the long-term averages, municipal bonds will remain supportive during June and July and provide investors an opportune time to rebalance portfolios (such as reducing credit risk).

Holiday Season – late November through year-end

Thanksgiving should indicate a warning sign to investors regarding optimal liquidity and ample supply. During the week of Thanksgiving, the markets may be open; however, the focus of the market is limited. The last week of November and the first two weeks of December represent the final opportunity for investors to efficiently trade before the market essentially shuts down for the year. Junior traders and reduced staff remain the norm during the last two weeks of the year. Market making and risk taking are severely restricted and a noticeable liquidity premium on bonds is apparent. Fortunately, for those investors looking to put cash to work, the ability to purchase bonds from forced market sells offers the opportunity to add exposure at discounted levels.

Sage has always believed that a well-informed investor is a successful investor. Investors looking to make strategic and tactical shifts into and out of municipal bonds can enhance returns by timing seasonal effects appropriately. By combining Sage’s value-based investment strategy with seasonal timing of cash flow, investors will be able to maximize market liquidity and optimize return potential.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

 

Valuations Become Attractive for Longer-Maturity Municipal Bonds

Posted on by Sage Advisory

With investor demand focused on the front end of the yield curve, longer maturities have been neglected, leading to a divergence from Treasury yield movements. We believe valuations for long-dated municipal bonds offer the high-taxed individual an attractive entry point here.

The 30-Year Municipal to Treasury ratio, M/T for short, is a common valuation indicator that can easily spot undervalued and overvalued market conditions. As of early February, the 30-Year M/T ratio was greater than 100%, which has historically been a great time to enter the market.

 

 

The benefit to taxable investors is that current 30-year municipal yields are offered at the same yield level as equivalent Treasuries. For an investor with a 35% effective tax rate, the after-tax benefit for owning municipal bonds equates to approximately 1.00% of additional yield. If investors can withstand a modest level of price volatility, extending the maturity profile of a portfolio’s bond allocation will pay dividends over time.

 

Disclosures: This is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.

Build America Bonds, The Fiscal Cliff & Insurer Portfolios

September 1, 2016 — With about two weeks to go until the stated deadline for Congress to address the automatic spending cuts set to be imposed on most federal agencies, one component that may have slipped under the radar for many insurance companies is the impact that the “Fiscal Cliff” (as these mandatory cuts are being called) would have on Build America Bonds (BABs).

Build America Bonds — Promises Made, Promises Broken

March 1, 2013 — The Build America Bond (BAB) program, established under the American Recovery and Reinvestment Act in 2009, was touted by the Obama Administration as a more efficient way for municipal issuers to sell bonds to the public, while maintaining revenue neutrality for the Federal government’s balance sheet. The proponents of this program claimed BABs to be a new era in municipal finance that would lower borrowing costs and increase demand for municipal bonds. With the expiration of the program at the end of 2010, a total of $182 billion of BABs where issued, all of which were structured as direct-pay. In an effort to restart this program, President Obama is proposing a similar plan called “America Fast Forward” which would provide a reduced interest rate subsidy of 28%.

Sage Advice Special Report 1Q2008

March 31, 2008 — Structured investment vehicles, or SIV’s for short, were created by offshore investment companies that sell short-term securities to purchase higher yielding long-term bonds and profit from the positive carry between the two. For SIV managers, longer dated securities such as mortgage backed and structured products were utilized to maximize the spread between the short and long positions. In turn, money market and short dated funds invested in the short dated paper sold by the SIV issuers due to the attractive yield relative to other short term products as well as its perceived safety and liquidity. The rise in market volatility that started at the beginning of 2007, shown below in the VIX chart, caused liquidity to quickly dry up and investors’ appetite for risk to suddenly wane.