Retail investors exit munis, accelerating decline

BOSTON (Reuters) - Fund investors abandoned the tax-exempt bond market for the first time since April over the past week, increasing pressure on municipal bond prices amid a host of other problems.

Mutual fund investors withdrew a net $115 million from tax-exempt funds last week, according to the most recent data from the Investment Company Institute. That marked the first week of net withdrawals since the week ended April 14, the fund industry trade group said.

The withdrawals reflect fears of higher interest rates hitting muni bond prices as well as the changing outlook for higher taxes next year with Republicans in control of the U.S. House of Representatives, analysts and financial advisers said.

“Funds are the largest players in the municipal market so to the extent there are outflows, that will put more upward pressure on rates,” said Jack Bauer, managing director of fixed income at Manning & Napier, a money manager in Fairport, New York, who oversees $25 billion in assets. “It’s been kind of ugly this week.”

Fund investors had been a source of strength for the muni market over the past six months, adding almost $20 billion in net new money since the end of April, according to the ICI.


The recent shift out of munis also hit exchange-traded funds this week. Volume has soared, spreads have widened and prices fell even more quickly than the drop in prices of the underlying bonds.

On Wednesday, for example, investors traded 1.3 million shares of the iShares S&P National AMT-Free Muni Bond ETF MUB.P -- almost 10 times its average daily volume over the prior three months.

The fund’s share price dropped to a low of $99.05 on Tuesday from over $105 on November 9. It partially recovered to $100.52 in afternoon trading on the New York Stock Exchange on Thursday.

The ETF’s price decline happened far more quickly than the drop in the prices of the bonds it owns, although the gap has narrowed during the week.

At the close on November 10, the ETF was priced at a discount of about 0.61 percent to the net asset value of its portfolio. The discount widened to as much as 3 percent in midday trading on Monday and Tuesday, but has since narrowed to 0.71 percent at the close on Wednesday.

The gap narrowed largely because the bonds’ value

eventually declined close to the share price of the ETF.

Such gaps can crop up when ETFs own assets like municipal bonds that are less liquid, essentially more difficult to trade, than the funds themselves, explained Jerry Paul, chief investment officer of Essential Investment Partners in Denver.

“With some ETFs, we just think the asset is better suited to active management,” he said.

Pressure on municipal prices has hurt shares of Eaton Vance Corp EV.N, a Boston-based money manager and a leading tax-exempt fund manager, one analyst who follows the company said.

Shares of Eaton Vance dropped from $31 to as low as $29.11 from Monday through Thursday’s open. The shares rebounded on Thursday along with a slight rebound in municipal bond prices. The shares were at $29.74 in afternoon trading on the New York Stock Exchange.

About 10 percent of Eaton Vance’s total assets under management are in tax-exempt funds and the muni market turmoil is weighing on the firm’s fund performance, Ticonderoga Securities analyst Doug Sipkin noted.

Reporting by Aaron Pressman; Editing by Jan Paschal