Alpha/Beta The Outlook For Muni Bonds And How To Play Them With ETFs Live Webinar April 28, 2011 2-3 p.m. EDT
Today s Webinar: Muni Bonds Matt Fabian Managing Director Municipal Market Advisors Matt Hougan President, ETF Analytics Global Head of Editorial IndexUniverse How To Evaluate Muni Bonds How To Evaluate Muni Bond ETFs
Municipal Credit Issues Evolution: November 2009, Jim Chanos in Barron s Associated Pension Liability and State Bond Default. Hedge Funds Had Two Strategies: 1) Force retail out of the market that would stress liquidity and cause prices to fall 2) Force budget decisions which would adversely impact lower stakeholders. Meredith Whitney Irresponsible or Part of Strategies. Newt Gingrich s Bankruptcy Policy Inflammatory. Media Sought a Pulitzer Prize Winning Story. Barron s New Bond King cited municipal markets weak psychological underpinning.
Benchmark Yields (%) Municipal Market Recent Activity Investors Feared the Worst and a Knowledgeable and Forceful Response Was Slow to Form MMA Benchmark 30-Yr Yields & OH Tobacco's 5 7/8 '47 5.50 10.20 5.20 4.90 4.60 4.30 S&P tobacco downgrade 11/12 Whitney on CBS 9.80 9.40 9.00 8.60 OH Tobacco Yield (%) 4.00 MMA on CNBC 8.20 3.70 7.80 10/15 11/9 12/4 12/29 1/23 2/17 3/14 MMA 5% MMA Par OH Tobacco (118217au2)
Municipal Bond Fund Outflows Have Persisted Roiling the Market 3 ICI Weekly Muni Mutual Fund Net Inflows ($Bn) 2 1 0 (1) (2) (3) (4) (5) Aug-08 Jan-09 Jul-09 Dec-09 Jun-10 Dec-10
Basis Points Precedent for Mutual Fund Redemptions Generating Adversity Municipal Yield Change and High Yield Level During Periods of Adversity & Illiquidity: Bond Buyer 20 GO Index 400 336 331 12.00 300 200 100 121 54 55 90 177 109 30 147 96 47 157 10.00 8.00 6.00 Yield (%) 0 4.00 Change (bps) Yield High (%) Source: Bond Buyer, MMA
Performance 1pt=1% The April 2011 Recovery Was Consistent in its Evolution with 2010 Nearly to the Day and Assisted by Low Primary Issuance. 1.00 Spring Municipal Price Performance and Issuance: 2011 vs. 2010 20% 0.50 0.00-0.50-1.00-1.50-2.00 10% 0% -10% -20% -30% -40% Change in 30-Day Supply -2.50 2-Mar 16-Mar 30-Mar 13-Apr 27-Apr 11-May 25-May -50% 30-Day Supply Annual Difference Cumulative Change 2010 Cumulative Change 2011
Despite Headlines, Defaults a Small Portion of the Total Market Credit Default Profile of Municipal Industry % Municipal Bonds in Default Since July 2009 120% 100% 100.00% $2.9 Trillion 80% 60% 40% 20% 0% Total Outstanding 0.27% $8.1 Billion Par in Default Since July 2009 0.00% $47 Million "Safe Sector" in Default Since July 2009
Institutional Bondholder Confidence Because of: A General Lack of Refinancing Pressure (which Mitigates Issuers Vulnerability to a Loss of Market Access); Very Manageable Annual Debt Service Expenses; The Limited Benefit from, and Lopsided Costs of, Default; Close Supervision of Transaction Structuring by Analysts Worried Exclusively over Default Risk; Flexibility by States to Set Revenue and Spending Policies and Account for same; Steadily Improving Management Sophistication; The Exceptional Structural Protections of Bondholders versus Other Government Stakeholders as Granted by State Bond Laws and State Constitutions.
Since July 2009: 272 Defaults None Are General Obligations Only 15 Rated
Yield (%) Access to the Capital Markets Dependent on Underwriter s Profit Potential and Investor Demand Average MMA AAA Municipal 10-Year Yield vs. Annual Total Issuance 6.00 5.50 5.00 4.50 4.00 3.50 3.00 $275 1988-2010 (Average) $192 1988-1999 (Funds) $283 2000-2002 (Futures Arb) $394 $389 $401 2003-2007 (TOB) 2008 (Crisis) 2009-2010 (BAB) $450 $375 $300 $225 $150 $75 $0 Avg. Annual Issuance ($B's) Annual Average Average 10-Year Yield
Redemption Monthly Change Narrow Demand Limiting Issuers Access to Capital Markets 2011 Could Be More Similar to 1990 s. Municipal Monthly Redemptions (IDC) v. Projected 2011 Issuance (Avg. 1988-1999): $200B 60.0% $24.00 40.0% 20.0% 0.0% -20.0% -40.0% $20.00 $16.00 $12.00 $8.00 $4.00 Issuance ($B's) -60.0% Jan Feb Mar Apr May Jun $0.00 2011 Change v. 2010 (redemptions w/out coupons) Projected 2011 Issuance
Municipal Bond Secondary Trading Has Declined Since the Leveraged TOB-Era Increased Illiquidity, Inhibited Price Discovery, & Reduced Revenue. 700 600 500 400 300 200 100 Monthly Municipal Bonds Par Traded ($Bn) 0 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Inter-Dealer Trades Customer Sells Customer Buys
Key to Municipal Evaluations Lies in the Price Discovery Associated with High-Grade Proxies and Transactions Particularly, Competitive AAA State GO Credits. Correlation MMA (Par) MMA (5%) MMD (5%) Wake Co., NC Aaa/AAA LMIS (Barclays) MMA (5%) 0.98 0.97 0.98 0.96 MMD (5%) 1.00 0.97 0.98 Wake Co., NC Aaa/AAA LMIS (Barclays) 0.97 0.99 0.95
Washington DC - Topics: Municipal Bankruptcy - The Gingrich Mantra Illiquidity - Are Investors Appropriately Informed About Their Municipal Holdings? Credit, Liquidity, Evaluation and Disclosure. Disclosure - Possible Repeal of Tower Amendment. Pensions - Greater Political Will and Support to Address Disadvantageous Terms. Build America Bonds - Democrats Still Explore, Republicans Resistant.
Five Critical Themes for 2011: Evaluation Process Under More Pressure. Illiquidity and Poor Price Discovery Leads to Greater Price Volatility. Credit Risks More Important Amid Ratings Ambiguity. Dealer Commitment to Market a Risk in Post BAB Environment.
THE MUNICIPAL MARKET ADVISORS TEAM Tom Doe CEO & Founder 978-287-0014 tdoe@mma-research.com Matt Fabian Managing Director 203-226-2398 mfabian@mma-research.com Matt Posner Director 202-368-4803 mposner@mma-research.com Tim Holler, CFA COO 941-739-9860 tholler@mma-research.com Lisa Washburn Managing Director 908.514.1244 lwashburn@mma-research.com Steve McLaughlin Managing Director 973-701-1111 smclaughlin@mma-research.com Eliza Bucens Director 978-287-0139 ebucens@mma-research.com www.mma-research.com Tel: (978) 287-0014
An obligation of states, counties, cities, and special tax districts to repay principal and interest of borrowed. What is a MUNI?
What Can Munis Do For You? Income generation Tax-advantaged Diversification
Tax-Advantaged Yield An Example Marginal Tax Rate: 25% Muni Bond Yield: 5% Corporate Bond Yield: 6% After-tax Muni Bond Yield: 5% After-tax Corporate Bond Yield: 6%*(1-0.25) = 4.5%
Muni Bond: Key Vectors of Analysis Different Repayment sources: General Obligation Revenue Backed Different Tax Treatment Different Credit Modifications
Muni Bonds: A Different Market Dealer driven market Predominantly dominated by Buy and Hold investors but like all bonds, credit quality and interest rate sensitivity matters.
Muni Bonds Choices Individual Bonds Mutual Funds Closed End Funds ETFs
Individual Bonds, Suboptimal Liquidity
Mutual Funds, Uncertain Payout and High Costs 000% 000% 000% 001% 001% 001% 001% Weighted Average Expense Ratio Average Expense Ratio Muni ETF Muni CEF (Unlevered, National) Muni Mutual Fund
Mutual Fund Pricing
Closed-End Funds Playing The Premium/Discount
Price Discovery Muni Bond ETFs: Goldilocks Or Mr. Inbetween ETFs Closed-End Funds Less Mutual Funds Premium/Discount Vulnerability More
ETFs, CEFs and Mutual Funds ETFs Mutual Funds Closed End Funds Premiums / Discounts Medium Low High Liquidity High Low Medium Costs Low High Medium
Passive vs. Active Pro Passive Lower Cost Greater diversification Reflective of the debt outstanding in the marketplace. Active Invests in bonds expected to perform the best Benefit of manager expertise Is not constrained by index rules Con Invests majority of $ in most indebted municipalities Constrained by underlying index, which is often uninvestable. Reactive to market events May not be reflective of the muni bond market Greater concentration risk Higher cost, no guarantee of outperformance.
Market Cap Weighting strategies Top 10 States MUB Top 10 States TFI California 23.26% New York 18.09% Texas 7.20% Puerto Rico 5.37% New Jersey 4.98% Massachusetts 4.67% Florida 3.89% Illinois 3.53% Georgia 2.83% Washington 2.49% New York 17.60% California 12.42% Texas 8.20% Florida 5.83% Washington 4.99% Illinois 4.16% Georgia 3.90% New Jersey 3.87% Ohio 3.24% Washington 3.19%
Challenges of Bond Funds: Super Optimization ETF Holdings Index Holdings SMB 183 5,847 ITM 377 13,075 PRB 79 2,560 MLN 150 6,018
Super Optimization
ETF Issues: Underlying (il)liquidity
ETF Issues: Create/Redeem for Cash
Benefits of ETFs: Intraday Liquidity Enter and exit Muni Bond ETFs during market hours Use to make market timing calls
Benefits Of ETFs: Price Discovery Provides guide for Underlying Index prices when liquidity is constrained Acts as guide for Dealers
Muni ETFs Before and Now
Flows ($, MM) AUM ($, MM) Muni ETF Flows and AUM 400 300 200 100 0-100 -200-300 9000,0 8000,0 7000,0 6000,0 5000,0 4000,0 3000,0 2000,0 1000,0 - Net Flows AUM at Period End
Evaluating Muni ETFs Efficiency: Large tracking error is common. Tradability: Fit: Premium/Discounts & high spreads are common. Active & niche funds may deviate from broad beta exposure.
Any Questions? Matt Fabian Managing Director Municipal Market Advisors Matt Hougan President, ETF Analytics Global Head of Editorial IndexUniverse
Thank You For more information: www.indexuniverse.com www.mma-research.com