March 9, 2012 / 5:12 AM / 7 years ago

Muni bond critics yield a gift for investors

NEW YORK (Reuters) - John Miller was on Christmas vacation in Florida in 2010 when Wall Street analyst Meredith Whitney said the $3.7 trillion muni bond market was about to crash.

Tom Shreier, Vice Chairman of Nuveen Fund Advisors (L) stands with Lars Asplund, Managing Director of Lipper, as he is presented the award for Best Overall Large Firm at the Thomson Reuters Lipper Awards ceremony, in New York, March 8, 2012. REUTERS/Chip East

Whitney, whose prestige soared when she correctly predicted Citigroup Inc’s cash crisis, told investors on national television to expect hundreds of billions of dollars in defaults among states and municipalities.

Miller, a co-head of global fixed income at Nuveen Asset Management, where he oversees $82 billion in municipal fixed income assets, crunched the numbers. Despite the headwinds facing local governments at the time, the figures didn’t add up.

While many investors heeded Whitney’s advice, Miller and Nuveen, which manages a total of $108 billion in assets, stuck to their guns. When the dust settled, demand for munis surged, contributing to the investment firm winning the overall fund family award for large companies this year from Lipper, a Thomson Reuters company.

The Lipper Awards recognize investment funds delivering consistently strong risk-adjusted returns in their respected categories. Nuveen won 20 individual 2012 Lipper Leaders awards on Thursday, including 17 for munis.

“If you don’t have a state filing for bankruptcy, you mathematically almost can’t get to hundreds of millions unless you’re seeing small issuers default every single day,” says Miller, adding that there is no legal mechanism for states to file for bankruptcy.

Munis were also under pressure due to the expectation of higher interest rates in 2011, and from a record amount of new issuance in 2010, particularly in the fourth quarter as the Build America Bond program was wrapping up.

The result of those three factors was a mass exit from muni bonds, including $13.5 billion of outflows in January 2011 alone.


By June 2011, investors were realizing that the worst case scenario was not going to bear out.

Local governments had made adjustments and cuts to protect their debt payments, interest rates ended up falling, and new issuance fell drastically, making munis hot commodities.

By the end of 2011, Barclays’ main muni bond index returned 10.7 percent, while the S&P 500 rose 2.1 percent.

“The returns were phenomenal,” says Tom Roseen, head of research services at Lipper, a Thomson Reuters company. “The pre-tax yields, in some cases, were higher than their taxable brethren, because of how badly they got beat up.”

Chicago-based Nuveen’s funds were no laggards. The Nuveen Maryland Municipal Bond Fund and the Nuveen Virginia Municipal Bond Fund won for a second and third year in a row respectively for five-year returns; while the Nuveen Tennessee Municipal Bond Fund won for a second year in a row for 10-year returns.


Looking forward, the prospects for munis are mixed.

In 2011, the double-digit returns they generated reflected a substantial fall in yields. The challenge for muni investors this year is that yields are close to, if not at, record lows, making it hard to find good value, says Rob Williams, director of fixed income and income planning at Schwab.

“At the same time, if yields are at current levels, it’s hard for them to fall much further and that’s what would be required to deliver the double-digit returns,” Williams says.

He recommended muni investors focus on the income from the bonds’ coupons rather than the potential for price appreciation.

But Miller says he still sees some opportunities, especially in lower grade munis, which return more income than investment quality bonds, but did not rise as much in price last year.

“There was less demand in high yield, and therefore, those credit spreads are higher and those prices are lower, so there could be some potential for good returns,” he says.

High-yield sectors Miller likes, on a case-by-case basis, include property-tax-backed bonds, health care, and education — more specifically, charter schools.

He said that as local governments continue to cut back on spending, 2012 is likely to be the second year in a row of negative net new issuance.

“That means it’s harder to find bonds, it’s harder to find yield; and I think it’s a stabilizing force to the marketplace and munis can outperform other fixed income based on that.”

Editing by Jilian Mincer, Beth Pinsker Gladstone and Andrea Evans

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