The two biggest muni managers during last year’s record breaking wave of issuance and demand expect the next 12 months to be less sunny.
“This year could be a little bit tougher than last year when we had the wind at our backs,” said John Miller, head of municipals at Nuveen, which captured $11.2 billion of muni fund flows in 2021.
Already the $4 trillion municipal bond market looks to be off to its worst start in more than two decades. While January is typically a strong month for munis, the asset class has been hit by the dramatic rise in Treasury yields, spurred by expectations the Federal Reserve will start to raise interest rates as soon as March.
The sharp increase in yields and a more hawkish Fed will be the “biggest headwind” for municipal bonds, Miller said in an interview.
Moreover, those tensions are likely to last for much of the year, with munis unlikely to match their 2021 outperformance, said Paul Malloy, head of municipals at Vanguard Group, which saw $24.5 billion in muni fund flows last year.
“Treasuries are really in the driver’s seat,” said Malloy. “While fundamentals are really good, we expect munis to move alongside Treasuries.”
Combined, Nuveen and Vanguard captured more than a third of last year’s muni fund flows, or money added to state and local-government debt funds, according to Refinitiv Lipper U.S. Fund Flows data.
Unprecedented demand, driven in part by investors’ fear of higher tax rates, helped drive strong muni returns that bested nearly every other fixed income asset class in 2021. But now, with funds flush with cash and valuations still richer than historical average, Vanguard is turning “back to basics,” Malloy said.
“It’s the kind of market, with everything compressed, we like better quality,” said Malloy, who oversees Vanguard’s $267 billion of municipal debt. “We don’t believe this is the time to go bottom feeding at these valuation levels. We are relying on credits with strong long-run fundamentals.”
That includes states and local governments that have continued fully funding their pension payments and bonds sold by colleges with strong endowments.