The well-heeled investor can still fit some munis in his or her portfolio. But it’s unclear what institutions will do with their municipal bond portfolios now that they’ve seen their tax bills dramatically reduced amid congressional reform.
Those were the arguments of BlackRock money manager Peter Hayes on Tuesday. The opportunities for municipal bond investing remain good even in a rising interest rate economy and despite last year’s Tax Cuts and Jobs Act, said Hayes, head of BlackRock’s Municipal Bond Group.
“The demand is still very strong,” said Hayes, whose Strategic Municipal Opportunities Fund has added about $10 billion in assets this year. The fund was up in February by 0.33 percent, outdistancing the sector, where the average loss was minus 0.49 percent.
High-yield municipal bonds have been the best performers in the muni sector. Hayes said this has been a long-term trend—that they’ve outperformed the sector in 10 of the last 14 years.
However, given the uncertainty about various governmental entities, about expected continued Federal Reserve interest rate increases and a negative return for munis in the first quarter, Hayes is watching what institutions will do with their muni bonds and is examining other defensive strategies such as reducing durations, he said at a news conference in Manhattan on Tuesday.
“Given rising U.S. Treasury yields, we maintain a low duration profile in the fund. We reduced exposures to maturities of 25 years plus and added maturities of zero to two years,” the fund’s March report said.
In another defensive strategy, Hayes is reducing credit risk and increasing fund liquidity. Although he has used high yield to beat market averages, he is cutting back. “We moved higher in quality by decreasing exposure to higher yielding “A” and “BBB”-rated issues,” Hayes recently wrote.
Another potential danger is the ability of municipalities to pay their teachers in light of recent strikes and the effect of political populism, Hayes said, problems that he said would be watched.
These things will affect municipal credit down the road. “So we are thinking about our portfolios in terms of revenue, where we have an identifiable revenue to pay back debt service,” he said. He compares that with trying to predict a bond issuer’s political problems in the long term, which is more difficult. “That is generally not what we do,” he added.
Still, Hayes argued that for the individual investor, municipal bonds still make sense. That’s because very little changed for those retail investors in higher brackets after the tax cut, according to Hayes. “There’s not really a big change in the after-tax yield on municipal income.”