U.S. municipal debt is set to trail stocks, commodities, Treasuries and corporate bonds in 2013 when adjusted for volatility, halting a two-year streak of outperforming those assets.
Bets that interest rates would climb, coupled with Detroit’s record bankruptcy and concern that Puerto Rico’s shrinking economy would make it hard for the commonwealth to repay its debt, undermined the $3.7 trillion local-bond market. Investors have pulled money from muni mutual funds since May, an unprecedented streak, Lipper US Fund Flows data show.
Though city and state debt joined a broader fixed-income selloff, the record outflows made munis more of a one-way bet. Benchmark yields have risen in nine of 12 months since setting generational lows in December 2012, data compiled by Bloomberg show. By comparison, Treasury interest rates have climbed in seven months this year.
“Yields pretty much went up most of the year,” said Chris Ryon, who helps oversee $10 billion of munis at Thornburg Investment Management in Santa Fe, New Mexico. After a September rally, “you just started moving up higher again.”
Munis have declined 0.9 percent this year through Dec. 26 after factoring in trading swings, according to data compiled by Bloomberg and Bank of America Merrill Lynch. Treasuries have lost the second-most, at 0.8 percent, followed by company bonds at 0.3 percent and commodities at 0.1 percent. The Standard & Poor’s 500 index of stocks, which has surged almost 30 percent in 2013, has gained 2.9 percent on a risk-adjusted basis.
Swing Band
Last year, local debt earned 3.8 percent when adjusted for volatility, and 4.4 percent in 2011, the highest among the assets for both periods. In 2010, munis trailed all areas.
Price swings on local-government obligations are smaller than on other assets in part because the securities don’t trade as often. Individuals own about 70 percent of municipal bonds either directly or through mutual funds, Federal Reserve data show. Those buyers typically hold to maturity. About a third of muni trades occur within a month of issuance, according to the Municipal Securities Rulemaking Board.
The relative stability penalizes munis’ risk-adjusted returns during years of decline because investors have fewer opportunities to capitalize on price fluctuations. Only in April, September and October did benchmark 10-year muni yields post monthly declines, Bloomberg data show.
Selling Squeeze