When Retail Runs for the Fences
By: Matt Owings
Like my toddler, from time to time, the municipal bond market can get a little grumpy. These market temper tantrums occur every two to four years or so. Each outburst has its own unique reasons for escalating, but one thing is certain, they all have OUTFLOWS. Municipal fund flows have been a powerful tool to help identify unique buying opportunities for long-term oriented investors in municipal bonds.
Over 50% of the municipal market is now owned by retail-minded investors either through individual securities, mutual funds, or ETFs. The retail domination of municipal bonds has developed into a powerful source of volatility. Why? When retail investors get nervous, they are generally quick to hit the sell button. Given the size of retail participation, this selling pressure can have enormous consequences for the general market. Since the Great Recession, regulatory changes that limit the size and trading capabilities of broker-dealers as well as the proliferation of municipal bond ETFs have helped strengthen this market dynamic.
When a large majority of retail investors decide to sell their mutual fund holdings at the same time, it can force redemptions causing funds to liquidate holdings at depressed prices. Many funds carry cash balances to help mitigate the damage in the early stages of a redemption period. However, if the outflows continue for multiple weeks or months, mutual funds and even ETFs are forced to begin liquidating positions. Long-term investors with an eye towards opportunity can wait patiently to strike and take advantage of these market dislocations.
Post pandemic, fund flows have been strong and steady in anticipation of higher tax rates and improving fundamentals at state and local government levels. But with the Fed threatening to raise rates in the coming months to combat inflation, we may be witnessing the beginning of another retail run on the funds. Last week alone saw over $4 billion of outflows (ICI), the largest since March 2020 during the COVID crash that rattled investors across the globe.
At Equus, we are watching closely to see if the outflows will continue. If retail investors’ fear takes hold, this Spring could add to the short-list of municipal market disruptions worthy of investors’ attention. These periods of liquidation can last a couple of weeks or go on for multiple months. Without knowing in advance when the stampede will start or how long it will last, it is wise to have some cash on hand ready to deploy while retail runs for the fences and potential opportunity presents itself.