FIXED-INCOME INSIGHTS Muni Matters: Seven Important Facts for Muni Investors April 10, 2017 Daniel S. Solender, CFA Partner & Director 1763 Views An analysis of key data points for 2016 can provide a clearer understanding of important trends in muni-market activity and areas of future opportunity. In Brief We think an examination of key trends in the municipal bond market based on data f or 2016 can help investors become more comf ortable with how the muni market operates. With that in mind, this article compiles seven important facts about the municipal bond market, with an analysis of each. Our observations cover important developments in: Trading volume by market type Institutional and retail trading patterns Time patterns in market activity The number, and type, of muni bonds being traded Activity in securities from the biggest muni issuers Characteristics of the most widely traded issues Types of key market participants The key takeaway We believe it would be beneficial for muni investors to carefully study the information compiled herein to help them be better prepared to identify opportunities in municipal securities. The U.S. municipal bond market has evolved tremendously over the past 20 years. One of the most important changes occurred during the late 1990s, when the Municipal Securities Rulemaking Board (MSRB) required dealers to disclose trade inf ormation within 15 minutes of the trade occurring. Prior to this change, market participants relied upon communication with dealers f or details about completed trades since the inf ormation was not widely disseminated. Over time, more inf ormation has become available, and the MSRB created a website with up-to-date trading data. These were revolutionary changes f or the municipal bond market, and helped attract more participants because they were no longer at an information disadvantage. Now, of course, the amount of available inf ormation has been greatly expanded. At the end of each year, the MSRB publishes a f act book that compiles data about the prior year and much of it is fascinating (to us at least) and quite instructive for those who want to learn more about how the market functions. 1
But which inf ormation should investors f ocus on? Drawing on the MSRB and other sources, this column presents seven illuminating f acts with accompanying data points about the municipal bond market f rom 2016. 1 We think this by the numbers approach to understanding munis can help investors become more comf ortable with how the market operates, and potentially help them to identif y attractive investment opportunities. 1. Trading Volume Was Solid, Especially in the Secondary Market Overall, the market value of municipal bonds outstanding was approximately $3.8 trillion on December 31, 2016, according to Federal Reserve data (which is updated quarterly). Nearly twothirds of the bonds are owned by individuals, either directly through owning individual securities or by having separately managed accounts or mutual f unds. During 2016, the total amount of municipal bonds that customers purchased was $1.6 trillion. This does not mean that a signif icant portion of the outstanding bonds were issued last year. Instead, it represents the total par value of bonds purchased through new issues or secondary trades, as some bonds traded multiple times between accounts. To get a sense of how many of these purchases were in the secondary market, data from The Bond Buyer show that the volume of new bonds issued during 2016 was $445 billion. There also was $36 billion of new short-term notes brought to market. So, af ter subtracting these f rom the $1.58 trillion of customer purchases, it is clear that there were a lot more bonds bought in the secondary market than the primary market. The total purchase volume during 2016 was the highest since 2012. 2. Institutional and Retail Trading Patterns Differed Now, let s look at the actual number of muni bond trades rather than the par value. When including both buys and sells, there were 9,358,046 trades during 2016. Of the total, 3,796,034 were customers buying, 1,917,322 were customers selling, and the rest were trades among dealers. On average, there were 37,135 trades per day for a total average daily trading par value of $12.4 billion. The interval of the day with the highest par value of trading was 10:45 11:00 a.m. ET, but the number of trades was f airly evenly dispersed between 10:30 a.m. and 4:15 p.m. This tells us that a good portion of larger institutional trading is transacted during the morning, while retail trades with individuals occur consistently throughout the day. It also suggests that dealers buy bonds f rom institutional investors primarily in the morning and then of ten re-trade them to individuals throughout the rest of the day. 3. Muni Market Activity Tended to Peak around Midweek Let s take a slightly longer view of the trading activity to examine weekly trends for 2016. The highest average par value of bonds traded was on Thursdays, with $15.1 billion of volume. Next highest was Wednesday, at $14.7 billion, with Monday being the lowest at $9.4 billion. It is interesting that the largest average number of trades occurred on a dif f erent day Wednesday with 40,666, with Tuesday being next highest and Friday, perhaps not surprisingly, being the lowest, with 30,945. Based upon these numbers, both institutional and retail investors are most active during the middle days of the week. 4. Lots of Different Bonds Were Bought and Sold Within those daily trading f igures, a surprisingly large number of individual bonds were changing hands. The average number of unique municipal bonds trading was highest on Wednesdays, with 14,032, and was lowest on Fridays, with 11,130. This f igure represents how many dif f erent bonds with different CUSIP security IDs were traded each day. It is interesting to compare the number of unique municipal bonds trading to securities in other markets. For example, when you think about equity indexes, the S&P 500 Index has 500 dif f erent underlying stocks, and the NASDAQ Composite Index has approximately 3,000. That s a total of 2
about 3,500 securities. The muni trading data in the preceding paragraph only represent the total number of securities trading each day, and represent just a f raction of the unique bonds actually outstanding. The market value of equities is larger, but the number of securities traded is much higher in municipals which is testament to how widely they are used across America to f inance governments, schools, airports, highways, hospitals, and other essential f unctions f or both large and small municipalities. Also, it makes clear that investment research is critical to dif f erentiate the credit quality among the large range of issuers. 5. New Bonds Traded More Frequently Than Old Bonds Another interesting way of looking at the market is how many of the bonds trading are from recent new issues. Many municipal bonds remain in portf olios permanently, and never trade or at least rarely trade. It turns out that 55% of the par value of bonds traded during 2016 was from bonds issued during the trailing 12 months. For example, this means that more than half the bonds trading during February 2016 (on a par-value basis) had been initially sold into the market since February 2015 or later. Only about 4% of the par-value trading in February 2016 was f rom bonds issued more than 10 years ago. The numbers are a little dif f erent when reviewing number of trades rather than par value. Only 35% of the trades occurring are from bonds issued during the last 12 months. This tells us that institutions do more trading with recently issued bonds, since they typically have larger, averagesized trades that allow the market value to be higher f or recently issued bonds, even though the actual number of trades is lower. They do not trade older bonds anywhere near as f requently. 6. Money Market Securities, Big Issuers Dominated Trading Stats The most actively traded bonds by par value in the muni market in 2016 were mostly money market securities. Of the top 10, only one is a f ixed-rate, long-term bond: the large Puerto Rico general obligation (GO) bond issued three years ago, which currently is rated Caa3 by Moody s and D by Standard & Poor s, since it is in def ault. Money market securities trade each day at par, with their coupons adjusting to yield movements rather than their prices moving as mutual f unds trade them daily to manage cash. So, while these are the most active, they are not a great representation of muni market activity. When reviewing the most active by number of trades, the highest was 8,092 trades for a bond issued by Saint John Baptist Parish (Louisiana) f or Marathon Oil, which is rated Ba1 by Moody's and BBB- by Standard & Poor s. It is a bond with a 5.125% coupon, a 2037 maturity, and a short call date, so it is a structure that is attractive to individual investors. Many of these trades were smaller transactions involving purchases by retail buyers. Others on the top f or highest number of trades were several GO issues f rom Illinois, and individual GO bonds f rom Puerto Rico and Pennsylvania. The New York Municipal Water Authority and the New Jersey Transportation Trust Fund also were high on the list. When removing money market securities and ranking by highest volume of par value traded, the top is the Puerto Rico GO (mentioned previously). The second highest is a Massachusetts GO bond, with a 4% coupon and a maturity of 2042, rated Aa1 by Moody s and AA+ by Standard & Poor s. This is a structure that typically has strong demand f rom retail investors due to the lower coupon and price close to par. The other issuers high on the list are GOs f rom Calif ornia (several issues), Illinois, the New York Transportation Development Corporation f or LaGuardia Airport, and Los Angeles (two bonds). One thing that is clear from reviewing the list of the muni bonds with the highest trading volume by par value is that it is dominated by many of the larger issuers. Issues from California and New York typically are high on the list, which is not surprising, given the population of each state. The Puerto Rico bond is high because hedge f unds have been actively trading that bond and their portf olios have high turnover. Illinois GO bonds have the highest yields of all the states, so many institutional investors have been adjusting their positions both up and down based upon their credit 3
outlook. Also, many individual investors have been attracted to the higher yields. Still, these are just the largest trading names and do not represent anywhere near the f ull universe of investment opportunities in the municipal bond market, although they probably are among the most liquid. If an investor were to review f und or separately managed account holdings, he or she would see a large, diverse set of issuers separate f rom the larger ones on this list. These smaller issuers can provide attractive value and of ten less volatility to investment f irms that have the resources to research the f ull range of sectors and can diversity an investor s portf olio. 7. Dealer Base Dwindles, but Smaller Investors Still Predominate To round out our list of the data points with the biggest potential inf luence on investor decisionmaking, here are two more. First, the number of dealers registered to trade municipal bonds has dwindled. During 2012, there were 1,787, but as of October 2016, the list was down to 1,448. This is still a good number of dealers (many of them are small in size), but the list is slowly shrinking and trading volume by par value is increasingly dominated by the larger firms. Second, there are a lot of municipal bond trades each day, but many of them are small. Of the average daily number of 37,135 trades during 2016, 965 were for par value $2 million or higher, while 582 were par value of $1 2 million. On the small side, 17,739 were $25,000 or lower in par value, and 7,329 were between $25,001 50,000. This means that more than half the trades were f or values less than $50,000. These trades were not necessarily made by just individual investors, because many institutions buy smaller positions to construct separately managed accounts or to grow institutional positions f or their f unds, but still, individual investors represent a large portion of these trades. This notion that some individuals are still actively buying bonds rather than selecting an investment manager is an interesting point to consider, given the market value impact f rom increased volatility in credit ratings in recent years and the wider bid/ask spreads f or smaller trades. Summing Up Based upon these statistics, it is clear that the municipal bond market is active and has many attractive opportunities. It also is clear that it is quite unlike other asset markets, given the large number of issuers, the trading patterns, and the range in sizes or volumes of trades. Given the unique trading patterns and investments, it is benef icial f or investors to caref ully study the inf ormation in order to be prepared when investments with attractive relative values emerge. With the MSRB s material data upgrades, investors have much more inf ormation available to help them understand the intricacies of the municipal bond market. 1 Unless otherwise noted, data presented herein are f rom the MSRB 2016 Fact Book. The inf ormation provided is f or general inf ormational purposes only. Ref erences to any specif ic securities, sectors or investment themes are f or illustrative purposes only and should not be considered an individualized recommendation or personalized investment advice, and should not be used as the basis f or any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be prof itable. Statements concerning f inancial market trends are based on current market conditions, which will f luctuate. There is no guarantee that markets will perf orm in a similar manner under similar conditions in the f uture. Past performance is not a reliable indicator of future results. This commentary may contain assumptions that are f orward-looking statements, which are based on certain assumptions of f uture events. Actual events are dif f icult to predict and may dif f er f rom those assumed. There can be 4
no assurance that f orward-looking statements will materialize or that actual returns or results will not be materially dif f erent f rom those described here. A Note about Risk: The value of an investment in f ixed-income securities will change as interest rates f luctuate and in response to market movements. As interest rates f all, the prices of debt securities tend to rise. As rates rise, prices tend to f all. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inf lation risk, and liquidity risk. The municipal bond market may be impacted by unf avorable legislative or political developments and adverse changes in the f inancial conditions of state and municipal issuers or the f ederal government in case it provides f inancial support to the municipality. Income f rom the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can af f ect them more signif icantly than the market as a whole. Because many municipal instruments are issued to f inance similar projects, conditions in these industries can signif icantly af f ect an investment. Income f rom municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. High-yield, lower-rated securities involve greater risk than higher-rated securities; portf olios that invest in them may be subject to greater levels of credit and liquidity risk than portf olios that do not. Lower-rated investments may be subject to greater price volatility than higherrated investments. A portion of the income derived f rom a municipal bond may be subject to the alternative minimum tax. Any capital gains realized may be subject to taxation. Federal, state, and local taxes may apply. There is a risk that a bond issued as tax-exempt may be reclassif ied by the IRS as taxable, creating taxable rather than tax-exempt income. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. Investments in Puerto Rico and other territories, commonwealths, and possessions may be af f ected by local, state, and regional f actors. These may include, f or example, economic or political developments, erosion of the tax base, and the possibility of credit problems. No investing strategy can overcome all market volatility or guarantee f uture results. A general obligation [GO] bond typically ref ers to a bond issued by a state or local government that is payable f rom general f unds of the issuer, although the precise source and priority of payment f or general obligation bonds may vary considerably f rom issuer to issuer depending on applicable state or local law. Most general obligation bonds are said to entail the f ull f aith and credit (and in many cases the taxing power) of the issuer, depending on applicable state or local law. General obligation bonds issued by local units of government of ten are payable f rom (and in some cases solely f rom) the issuer s ad valorem taxes, while general obligation bonds issued by states of ten are payable f rom appropriations made by the state legislature. Par value represents the amount of principal of a security that must be paid at maturity. The par value may also be ref erred to as the f ace amount of a security. Yield is the annual interest received f rom a bond and is typically expressed as a percentage of the bond's market price. The credit quality of the securities in a portf olio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor's, Moody's, or Fitch, as an indication of an issuer's creditworthiness. Ratings range f rom AAA (highest) to D (lowest). Bonds rated BBB or above are considered investment grade. Credit ratings BB and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may af f ect the issuer's ability to pay interest and principal on these securities. The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments 5
in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision. Investors should carefully consider the investment objectives, risks, charges and expenses of the Lord Abbett Funds. This and other important information is contained in the fund's summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, you can click here or contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388. Read the prospectus carefully before you invest or send money. Not FDIC-Insured. May lose value. Not guaranteed by any bank. Copyright 2018 Lord, Abbett & Co. LLC. All rights reserved. Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC. For U.S. residents only. The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances. 6