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Written by: Mark Paris and Stephanie Larosiliere | Invesco
Our team is finding opportunity among short-term and high-yield municipal bonds, as well as in sectors like healthcare.
Mark Paris, Chief Investment Officer and Head of Municipals, and Stephanie Larosiliere, Head of Municipal Business Strategies and Development for the Invesco municipal bond team, recently spoke about the current state of the municipal market with Tim Spitz, Product Director for Municipal Strategies.
Tim Spitz: Mark, where do you currently see opportunities in the municipal market?
Mark Paris: We believe there are opportunities in the short end of the municipal market. Short-term municipal rates appear attractive right now versus similarly rated taxable bonds.1 And even amid lingering concerns about volatility, we believe they offer a better yield than money market funds while not adding much potential price volatility.
We also see value in high yield municipal bonds. While investment grade municipals have rebounded, high yield continues to lag due to concerns over future economic growth and the level of economic stress that lower-rated municipal bonds may be able to handle. We believe high yield credit spreads should continue to tighten as the economy re-opens in various parts of the US. Credit research is critical in these times of uncertainty, in our view. Because the municipal market represents a large number of issuers with esoteric characteristics, it is important to focus on each individual credit’s metrics along with its sector. We believe Invesco Fixed Income’s (IFI) municipal credit team of 22 experienced credit analysts with an average of nearly 20 years of municipal bond investing experience provides our active portfolio management team with an edge when it comes to finding hidden gems that may have been cast aside simply due to their sector.2
Tim: Stephanie, are there specific sectors or credits that offer potential opportunities?
Stephanie Larosiliere: One example would be healthcare. Although hospitals are under increased stress as the Covid-19 crisis continues, certain hospitals have strong financials and are supported by favorable demographics and geographies. We believe IFI’s ability to pick through a sector and identify attractive risk-reward opportunities can potentially add value for our clients. When the market perceives stress, causing prices to decline across a sector, we look to fundamentals to judge whether a particular credit is being priced fairly based on its own merits or is just being lumped in with other credits. This “bond picking” strategy allows us to examine creditworthiness and market sentiment and make thoughtful decisions about what we want to own and not own.
Tim: Have any steps been taken to repair liquidity in the municipal market?
Mark: After a hiccup in the late first quarter and early second quarter, primary issuance in the municipal market is functioning normally again. In March, the federal government stepped in to support liquidity in the municipal market, lowering rates on 7-day paper from over 5% to current levels of under 0.5%.3 The federal government also created the Municipal Liquidity Facility (MLF), which allows the US Federal Reserve to provide credit to states and local governments through the purchase of short-term municipal notes with maturities of up to 36 months. Both programs have helped relieve stress on secondary municipal market prices and created liquidity for issuers.
Although the municipal market has not benefited from some of the additional programs that have helped the corporate and taxable markets, there have been some positive developments and we believe there may be more to come. IFI has been asked to consult with various government agencies and we continue to provide our thoughts on ways the government could help the municipal market in this time of crisis.
Tim Spitz: How has the municipal marketplace benefited from various stimulus packages coming out of Washington, D.C.?
Stephanie: The CARES Act [Coronavirus Aid, Relief, and Economic Security Act] provided financial assistance to many issuers in the municipal market when it was signed into law in March. Over $400 billion will directly or indirectly benefit municipal issuers with $150 billion going to state and local governments and $100 billion to healthcare providers, such as hospitals.4 As we talk [late July 2020], discussions in Washington are ongoing regarding additional economic stimulus, with both sides of the aisle agreeing that dollars should flow to state and local governments — the question is, how much? One answer we are fairly certain about is that someone will have to pay for these stimulus packages. This likely means tax increases down the road and a higher value placed on the tax-exemption that municipals provide.
Tim: Given the growing importance of socially responsible investing (SRI), how is Invesco incorporating SRI into its municipal strategies?
Mark: We recognize the importance of considering environmental, social and corporate governance (ESG) issues. As a result, ESG analysis has been incorporated into the credit process, including quantitative and qualitative reviews of ESG-related risks and their potential impact on an issuer’s credit profile. Specifically, issuer scorecards track data on ESG-related factors, compare them to peers and measure historical progress. Analysts also raise ESG awareness with management teams through active engagement and dialogue.
In making investment decisions, the municipal team applies a proprietary screening tool based on ESG principles. The output is a universe of sectors that we believe provide sustainable value, in addition to labelled-green bonds. The general overlay is a broad-spectrum approach to impact investing where assets are allocated to available investment opportunities with impact potential. These include opportunities related to the environment, education, housing, healthcare, social improvement, energy efficiency and infrastructure improvements, among other focus areas.
Related: Bond Investing in the Era of Low and No Yield
Footnotes
1 As of August 3, 2020, 2-year AAA General Obligation municipal bonds were yielding 113% of Treasuries of the same maturity, 3-years were yielding 112%; and 5-years were yield 102%.
2 Team size and team’s average years of experience are as of July 31, 2020.
3 Source: Securities Industry and Financial Markets Association, (5.20%) March 23, 2020 (0.11%) July 10, 2020.
4 Source: US Department of the Treasury, March 27, 2020.
Important Information
Definitions:
Credit spread: A credit spread is the difference in yield between a U.S. Treasury bond and another debt security of the same maturity but different credit quality. Credit spreads between U.S. Treasuries and other bond issuances are measured in basis points, with a 1% difference in yield equal to a spread of 100 basis points.
Labelled-green bonds are bonds that earmark proceeds for climate or environmental projects and have been labelled “green” by the issuer.
Municipal securities are subject to the risk that legislative or economic conditions could affect an issuer’s ability to make payments of principal and/ or interest.
Money market funds vs. mutual funds: A money market fund, which invests in very short-term securities considered safe, such as those issued by the US Treasury, is designed to maintain a stable net asset values of $1 per share, with the goal of providing principal stability. Mutual funds offer the potentially to earn higher yields, but their net asset values will fluctuate in accordance with changes in the value of their underlying securities, and they therefore cannot offer the potential principal stability money market funds do.
Municipal vs. taxable bonds: Municipal bonds are issued by state and local government agencies to finance public projects and services. They typically pay interest that is not subject to federal regular income tax or state and local income taxes in their state of issuance. Because of their tax benefits, municipal bonds usually offer lower pre-tax yields than similar taxable bonds. But when taxes are taken into account, the taxable equivalent yield on a municipal bond could be, depending on an individual tax’s bracket, higher than the yield available on a taxable bond of similar quality and maturity.
The opinions referenced above are as of August 5, 2020. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.