Munis Did Their Job in 2018
Updated: Jan 23, 2019
Munis Provide Added Diversification:
In a year when most other asset class returns were negative, bonds did their job. As seen in the chart below, municipals outperformed even without taking into consideration their tax-exempt status.
High Yield Munis Outperform...Again:
Boasting a 5.23% total return for 2018, the continued demand for yield resulted in strong outperformance for the high yield municipal sector. Five years in a row of cumulative outperformance relative to investment grade municipal bonds illustrates the resilience and strength of this unique sub-sector of the municipal bond market. This sector requires significant credit work to avoid problems and have a deep understanding of each issuer. However, the work pays off as seen the chart below. For a more risk tolerant investor, an allocation to high yield munis can increase yield, boost total returns and add considerable diversification benefits to a generic municipal bond portfolio.
Opportunity on Front End of Curve:
Despite the Fed raising rates four times in 2018, the front-end of the yield curve was also a top performing asset class. Yields on shorter dated maturities reached levels not seen in over a decade. Relative to years prior, these higher yields allowed investors to earn more income without taking as much duration risk.
Interest Rate Volatility:
Yield levels across the curve rose for the first 10 months of 2018 creating a frustrating bear market for bonds through October. In the final two months, equity market volatility, weaker economic growth outlooks and a disruptive political environment caused the traditional flight-to-quality to fixed income. For the year ended, 10-year MMD rose 30 basis points and the 30-year rose 47 basis points creating a steeper municipal curve in longer dated bonds.
Retail Investors Surrender too Early:
During the worst of the bear market beginning in September, investors fled the asset class. For 13 weeks in a row, investors withdrew over $10 billion from municipal bond funds missing out on the strong rally beginning in mid-November. Interestingly, $4 billion in outflows occurred even after the municipal bond market began to recover during the final two months of the year.
While the rally in the last two months sent yields lower, we are still starting 2019 at higher rates. This is good news because higher yields result in lower duration and higher income potential.
The front-end of the curve offers significantly elevated yields compared to the last 10 years and is especially attractive for those concerned about rising rates.
High yield munis have obviously done quite well over the past several years. As we look ahead into 2019, we are cognizant of the risks associated with the later stages of an economic cycle. Even so, we continue to believe high yield munis deserve an allocation to a diverse municipal bond portfolio. They can significantly increase the yield on a portfolio and provide added diversification benefits.
This report is for informational purposes only and should not be considered a solicitation to buy or sell any security. Past performance is not indicative of future results. Index returns are for illustrative purposes only and do not reflect management fees, trading costs, and cash drag impacts. Neither Equus Private Wealth nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Nothing herein is intended to provide enough information to make an investment decision. Investing in securities exposes the investor the risk of loss of prinicipal. Redistribution is prohibited without the express written consent of the Equus Private Wealth Management, LLC. Data for this report comes from Bloomberg, Morningstar and S&P Dow Jones Indices.