Sean Burke, head of the Remi Specialist team at Allspring, speaks with Nick Venditti, senior portfolio manager and head of the Municipal Fixed Income team, and Kim Nakahara, senior research analyst and portfolio manager for the Municipal Fixed Income team, about why now is a great time for investors to consider municipals.
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Sean Burke: I’m Sean Burke, head of the Remi Specialist team at Allspring, and you’re listening to On the Trading Desk®. For our featured conversation, we’re discussing why now: opportunities in municipal markets today. Joining us are Nick Venditti, senior portfolio manager and head of the Municipal Fixed Income team, and Kim Nakahara, senior research analyst and portfolio manager for the Municipal Fixed Income team. They will be providing their insights on the municipal bond market. Nick, Kim, thanks for being here today.
Nick Venditti: Thank you for having us.
Kim Nakahara: Thanks, Sean.
Sean: So, let’s start with the punchline. Nick, can you take us through a summary of reasons why now is a great time for investors, particularly tax-sensitive ones, to consider municipals today?
Nick: Absolutely. Look, in our minds, municipal bonds are frankly a homerun right now, both on an absolute and relative basis—on an absolute basis because yields are so much higher today than they were at this point last year. It’s not uncommon to buy a bond with a maturity inside of 10 years that yields 4%—solid investment-grade credits with maturities inside of 10 years that yield 4%. Do the after-tax calculation on that and you get to a number up close to 7%. That’s pretty attractive. Most investors I know would happily clip 7% today; tomorrow; and, frankly, every day until the end of time. And on a relative basis, munis look pretty good because there is a lot of volatility in the world in which we’re living. And by virtue of the asset class that we’re talking about here, we’re talking about less volatility, right? Munis are less correlated to equities. They are less correlated to Treasuries. And they are less correlated to some of the geopolitical events that are taking place in our world. I don’t want to shock anyone, but it turns out the water and sewer system of Milwaukee, Wisconsin, is less impacted by Russia and Ukraine than is Exxon Mobil. And that’s a pretty great story for investors in a volatile world.
Sean: As we think about opportunities today, rates across the municipal market have vastly increased on a year-over-year basis. Can you take us through a few strategies that the team recently deployed in the new rate environment?
Nick: I think this is a great time for investors to sort of holistically reassess risk. If you look at our team, the municipal bond team here at Allspring, we have a pretty simple philosophy. We come into the office every day and ask ourselves, are we getting paid to take risk? And if the answer is yes, then let’s go take some risk. But if the answer is no, let’s be content to do the boring thing—because the boring thing is probably the prudent thing. So, let’s think about risk in light of the changing environment. If you dumb down our job to kind of two levers, we have duration and credit available to us. Certainly, duration looks a lot cheaper. It looks cheaper because, as you said, Shawn, absolute yields are so much higher. And, so, across all of our portfolios, we are incrementally adding duration. But we’re doing that cognizant of the fact that the yield curve is still pretty banged up from a shape perspective, right? You have a Treasury curve that is heavily inverted 20 to 30 years. For us, that means that we can buy a 20-year bond and it yields about 95% of a 30-year bond but with only 80% of the duration. That’s a good trade, right? That’s a trade investors should be making every day. So, we are adding duration, but we’re doing it incrementally. We’re doing it prudently. And, similarly, on the credit side, look, credit spreads have widened out some. But as we are heading into what is almost certainly a recession, there is a chance that we see further credit spread widening, so we’re taking this opportunity to very selectively add credit exposure up and down our portfolios for our investors.
Sean: Yeah, prudent investing. That’s really the key. Sounds like the team is hard at work given the dramatic moves in the rate markets this year. Speaking of current environment, Kim, the last time we had you on the podcast was for a discussion on the U.S. midterm elections. Are there any new takeaways for the municipal investors on a split government?
Kim: When I was on the podcast, I talked about one of the things we were looking for was a change in control as being impactful to the municipal market. And, so, from that perspective, I think that the midterm election outcomes are really at credit neutral. There are two factors that are really going to change the muni market. It’s going to be a change to the tax exemption or some sort of large stimulus or infrastructure program. And I don’t think either one of those are likely under this divided government.
Sean: Finally, with the time we have left, Kim, most economists on the street are calling for a recession for the first half of 2023. Nick actually just mentioned it. Does that change how significant individual credit research is to portfolios at this time and going forward? And can you leave our listeners with an outlook on the municipal credit market and, more broadly, on the asset class for investors?
Kim: So, the short answer to your question is yes, it does change how important individual credit research is. I do want to make a couple of observations first about the underlying strength of municipals. First, one of the features that makes munis so attractive is the relatively lower risk. Historically, a BBB-rated municipal bond has a 0.95% cumulative default rate, which is lower than the historical cumulative default rate for AAA corporate. So, on a risk-adjusted basis, munis are an attractive option. The other observation I wanted to make about the underlying strength of munis is that, overall, state and local governments did better during the pandemic than we had expected. Governments were able to build up reserves. The unprecedented amount of stimulus funding has given our market a longer runway to make changes—adjustments to really get their financial houses in order so that munis are in a better position to respond to a recession than they were during the last decade. Having said all of that, I do think that the current market offers us an opportunity to be more selective in our investments to really focus on returning attractive yields for our investors. So, before I sign off, I just wanted to address your question about recession projections. And I would say that recession and other stress scenarios are really times when credit research and professional management take on even greater importance. Stress always amplifies credit distinctions, and without someone to do the research, sometimes it’s hard to see the stress or it’s not always obvious. If I could give a couple of specific examples, if we look back to the last recession, there were municipal bankruptcies: Stockton, Vallejo, San Bernardino. And these are names that our research team was able to identify as challenged credits early on and we were able to avoid the general fund credits and the bankruptcies. Looking forward, some of the pandemic-related federal and state funding for school districts is going to expire and the districts are going to face funding challenges and higher expenses. So, again, I think that these are just times when it helps to have a dedicated credit team sift through the noise and figure out what different levers each borrower has to pull to manage those finances.
Sean: Kim, Nick, thank you for that very timely insight on the municipal bond market.
Kim: Thanks for having us.
Nick: Our pleasure.
Sean: That wraps up this episode of On the Trading Desk®. If you’d like to read more market insights and investment perspectives from Allspring Global Investments, you can find them at our firm’s website, allspringglobal.com. To stay connected to On the Trading Desk® and listen to past and future episodes of the program, you can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you go to get your podcasts. Until next time, I’m Sean Burke and thanks for listening.
Disclosure
The ratings indicated are from Standard & Poor’s, Moody’s Investors Service, and/or Fitch Ratings Ltd. Credit-quality ratings: Credit-quality ratings apply to underlying holdings of the fund and not the fund itself. Standard & Poor’s rates the creditworthiness of bonds from AAA (highest) to D (lowest). Ratings from A to CCC may be modified by the addition of a plus (+) or minus (-) sign to show relative standing within the rating categories. Moody’s rates the creditworthiness of bonds from AAA (highest) to C (lowest). Ratings AA to B may be modified by the addition of a number 1 (highest) to 3 (lowest) to show relative standing within the ratings categories. Fitch rates the creditworthiness of bonds from AAA (highest) to D (lowest).
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