Sour investors on Muni Funds
Investors withdrew $1.4 billion from municipal bond funds in the week ending last Wednesday, the largest weekly outflow since the early days of the pandemic, according to Refinitiv Lipper.
Yields on municipal bonds, which rise as prices fall, soared last week after the Federal Reserve announced it would start raising interest rates steadily in mid-March, reducing the attractiveness of outstanding debt. Yields on top-rated state and local bonds jumped to 1.55% on Monday from 1.34% last Tuesday, according to Refinitiv MMD.
Yields for the S&P Municipal Bond Index fell to minus 2.33% this year through January 28, counting price changes and interest payments, the lowest returns since the start of the year for at least 16 years.
“The message is becoming increasingly clear that the calendar is moving forward and the Fed is going to be quicker,” said Yingchen Li, co-head of municipal research at Bank of America.
The waning interest in municipal debt in 2022 marks a reversal from 2021, when investors poured money into municipal bond funds as a federal stimulus and a booming economy bolstered corporate credit. States and local governments. This trend has lowered the cost of building schools, sewers and other capital projects, but now these expenses are increasing.
Helping to exacerbate volatility in the historically quiet $4 trillion market is a long-term shift in how bonds are bought and sold: individual investors are increasingly likely to sell bonds at down and bond brokers are less and less likely to buy them.
Affluent households who make up the bulk of the market once treated munis as an investment to be held, hanging on to maturity while receiving regular interest payments that are often tax-free. Today, these investors increasingly hold munis through mutual funds, segregated accounts, or exchange-traded funds — holdings that are easier to sell in the face of bad news.
At the same time, rules established after the 2007-09 financial crisis have made dealers less inclined to keep municipal debt on their balance sheets, meaning there are few ready buyers when skittish individual investors sell. .
“We literally had the discussion: OK guys, we now have a week of cash out, what’s our cash? Should we withdraw this money? said Lyle Fitterer, who manages about $6.5 billion in municipal bonds as co-head of the municipal bond team at Baird Advisors. “We don’t want to be the people forced to sell in this environment.”
Ease of exits and scarcity of buyers worsened the municipal market liquidity crisis of March 2020, when withdrawals of funds by panicked investors caused prices to plummet to the point that local governments had to cancel deals due to lack of funds. buyers. But momentum also plays a role in how the market reacts to more minor shocks like the Fed’s announcement that it is ready to raise rates in March and may continue to raise rates at an accelerated pace. .
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On Tuesday, the amount of debt investors sold to bond brokers exceeded the amount investors bought by more than $1 billion, according to data from the City Securities Regulatory Council, a rarity in the muni market. high demand and low supply. The last time this happened was in September 2020.
Mutual fund and exchange-traded fund holdings are now even larger than they were at the start of the pandemic, while dealer balance sheets have continued to shrink. Bond funds are managing about $1 trillion combined, 20% more than at the start of 2020, according to Federal Reserve data from September 30, the most recent available. Dealers hold about $12 billion, down 27% from pre-pandemic levels, though those holdings have been growing slowly over the course of 2021.
“We depend on mutual fund flows more than any other market,” said Patrick Brett, head of municipal debt capital markets at Citigroup, who also chairs the Municipal Securities Rulemaking Board, the self-regulatory body of the municipal bond sector. “We need buyers to step in when there are mutual fund outflows.”
Write to Heather Gillers at [email protected]
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Appeared in the February 1, 2022 print edition as “Investors Sour On Muni Funds With Fed’s Shift”.