Opportunities for municipal bond investors in 2013AdvantageVoice® Blog—
We recently talked with Lyle Fitterer, Head of the Wells Capital Management’s Tax-Exempt Fixed Income team, about what municipal bond investors might expect in 2013.
Where do you think the best opportunities will be in the tax-exempt market in 2013?
Let’s begin by looking at where the muni market has come from. The last four years have been almost a one-way market, with municipal bonds providing handsome total returns to investors despite plenty of volatility in the marketplace. Much of the opportunity has been in credit, and credit spreads have declined throughout this period.
The easy money seems to have been made, meaning that it served investors well to own long-dated and lower-quality credits over the last four or so years. Going forward, we believe it will be more important to focus on the specific credit quality of individual securities rather than broad categories of credits.
If finding specific credit opportunities is the way to add value, in what areas of the market does your team expect to find these opportunities?
We think there’s value in local general obligations (GOs). It’s an area that many people are fearful of because some states have pushed their state-level problems down to the local municipalities. However, I think the scope of the problem regarding local GO debt has been overdone in the media. There are many good local GO credits out there, and if you do your homework, you can take advantage of those opportunities.
In our longer-maturity products, we specifically like California school district GO debt with a zero-coupon structure. Another credit we like is in Michigan—the Detroit water and sewer system—because our analysts have found it to be a strong credit. While there is volatility associated with any credit that has the name “Detroit” in it, this is an attractively priced, essential-service revenue bond.
We also like floating-rate notes (FRNs). These are municipal securities with a long-dated final maturity (generally two, three, five, or 10 years) and a coupon with an adjustable rate that resets over shorter time periods. These are not variable-rate demand notes, which have a seven-day put feature. We like FRNs for several reasons: 1) If interest rates start to rise, their coupons will reset higher, and 2) because absolute yields are so low, we aren’t giving up much income by owning an FRN, and we are getting price protection compared to a fixed-rate bond.
We also see some opportunities within the health care sector, and we believe some opportunities remain in the high-yield market. In general, most of the new high-yield issues we’re seeing aren’t attractive to us, but we are finding opportunities on a case-by-case basis and also within the secondary market.
What else will you be watching in the year ahead?
Obviously, the level and direction of interest rates will come into play. Given a steep yield curve and low interest rates, we think the ratio of high-quality municipal bond yields compared to Treasury bond yields looks attractive and has room to narrow. This is especially true for the short and intermediate parts of the yield curve and less so with long-term bonds.
A wildcard is potential legislative change. Will Congress limit tax exemption for municipal bonds? We expect market volatility as Congress and the White House debate the federal budget and negotiate around the debt ceiling and sequestration, but we don’t think they’ll get rid of the tax-exempt muni market. There are many issuers in the muni market that simply couldn’t issue in the taxable market because they don’t bring large enough deals and aren’t index eligible, which is important for taxable investors.As we look ahead to 2013, we expect municipal bond total returns will be lower than they were in 2012. However, with good credit research, total returns should be reasonable this year. And periods of market volatility, such as during the deficit reduction talks in Washington, D.C., may provide an opportunity to buy undervalued municipal securities.
The views expressed are as of 2-15-13 and are those of Laurie King, Lyle Fitterer, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.