Celebrating 5 Years of Identifying Opportunity in the Municipal Market

Updated as of January 2022

As we celebrate the five-year anniversary of the SBH Municipal Opportunities strategy, we reflect on how the municipal market has changed. For an asset class that many consider boring, the muni market has given investors a bumpy ride recently yet still offers the potential for attractive income and return, in our opinion.

So, how has the market changed? What lessons have we learned? And what lies ahead for municipals? Hear the answers to these and other questions in our video interview with municipal specialist Nick Foley.

[Mark Rewey] Nothing boring about our guest today, Nick Foley, Senior Municipal Opportunities Portfolio Manager for Segall, Bryant, and Hamill. Joining us today, Nick, congratulations on a successful five years managing the strategy. Take us back. Where did the interest in municipal bonds, and becoming a portfolio manager come from?

[Nick Foley] So when I started out in fixed income, I was a more of a generalist. So I traded corporate bonds, mortgage-backed securities, aspect securities, treasuries, and then the S-class no one wanted to trade, was municipal bonds. And as I worked across all those, I started to realize and really feel that the area I could add the most value in was actually municipal bonds. So I started delving a little bit deeper and deeper into the market, and the further I went down that rabbit hole, the more and more fascinated I became with it. And so at that point I realized I’d found what I wanted to do with my career. And I wanted to find a full-time role where I could focus a hundred percent of my time on it. And that’s how I ended up at Segall Bryant.

[Rewey] So why did you start this particular strategy?

[Foley] We had been managing municipal bonds for about 30 years. We’d been running a mutual fund, but as we looked out at basically all the options that were available to investors, we realized pretty quickly that it felt like there was something missing. There hadn’t really been a whole lot of progressive thinking and new strategies, new ways to go about things. It just seemed as though conventional had somewhat worked over the last 30 years. And so everyone was just sticking with that. And as we looked at that, we became pretty convinced that there was probably a better way to go about things. And so that was really the genesis, it’s just starting with a blank page and saying, “Starting day one, what is the best way to allocate capital in this market? Is there a better way?” And we became very convinced there is a better way. And so five years later, you know, we feel very happy and proud of how that’s worked out.

[Rewey] Reflecting back as manager of the portfolio, have you seen the muni market change or what has surprised you most?

[Foley] The thing that’s the most surprising is actually that nothing, not nothing, but not a whole lot has changed. We’ve seen these massive innovations across other fixed income asset classes, corporate bonds, equities certainly, and meanwhile, the municipal market has stayed very much the same. If anything, a lot of the issues we’ve seen in the municipal market five years ago have actually even gotten worse. To the extent that we actually think that some of the inefficiencies that we take advantage of are actually getting better for us, so.

[Rewey] What do investors need to know? Or what are some misconceptions around the municipal market?

[Foley] Yeah. Misconceptions are similar to my initial introduction to muni’s is that it’s just a boring market where not a lot happens and it’s sleepy, and yeah, and from that what I would say is, and what our conviction is, is that it is actually one of the most complex fixed income markets that exists out there. As we look at the structural nature of the market, the amount of optionality in the market, how that optionality is priced, the sheer number of issuers, we feel, and we feel we can prove with a pretty high degree of conviction that it’s actually one of the most complex markets that exists.

[Rewey] So how do these misconceptions play into the opportunities that you see?

[Foley] Yeah, absolutely. It plays in perfectly, in the sense that, essentially if you have an investor base that’s out there saying, “We don’t need to spend a whole lot of time looking at this market. We don’t need to do a whole lot of work in this market. We don’t need to dig deeper.” That’s exactly where you want to be. If you’re an institutional investor, right, the deeper and darker the hole is that no one wants to go into, that’s usually where the best opportunities are. And so from that standpoint, that’s what makes us, allows us to do what we’re able to do is that if you’re willing to do a lot of the work, a lot of the grunt work, information is not readily available in the market, so you have to work increasingly, it’s increasingly hard to find any small bit of data that’s out there that can help you with a certain issuer or with what’s going on in the market. But as you find those things, the value you can create from them is exponential in our minds, so.

[Rewey] Fourteen years in the business. Today, what concerns you most?

[Foley] Yeah, what concerns me the most, by far, is what we’ve seen in the high yield market over the last, I would say, about decade. So we’ve seen this massive growth in the underlying high yield market, and we’ve seen a massive amount of flows into the high yield market, which is justified as the asset class has done very well. But what’s happening, and what people don’t see is that as more and more money flows into that market, there’s more money than there is bonds in that market. And so what happens is that issuers are able to get away with doing worse and worse covenants, which are the things that protect bond investors if something goes wrong, and essentially pricing has gotten so aggressive that you’re really not even paid for even a very small, incremental amount of risk. And so our fear is that the sheer volume of flows that have gone into high yield strategies is at some point going to reverse. And when it does reverse, the question has to be asked, of who’s going to be that incremental buyer when things get bad? And our view is that, again, for a shopping mall in New Jersey that’s non-rated, the buyer, incremental buyer, that is likely not going to be asking for a couple points down to buy that bond. They’re going to be asking, or they’re only going to be willing to pay for just cents on the dollar. And so that’s really what concerns us the most. We don’t think it’s a question of if, it’s more just a question of when.

[Rewey] So the muni market’s a crowded space.

[Foley] Yup.

[Rewey] Lot of managers, lot of strategies, a lot of big brand name firms.

[Foley] Yeah.

[Rewey] What separates you from everybody else? What’s your hook?

[Foley] Our hook is that we just think about things a little bit differently, I guess, is the easiest way to put it. We look at the market from, not necessarily, how is the benchmark allocated per state, right, so we step back and we look at the benchmark, and 33% of the entire benchmark is in California and New York, right? Well, those are the two highest income tax states as well. And so people in those states are willing to pay up to own bonds in those states. We step back and we say, not just, “Well, the index owns 33% California, New York, we should go buy 33% in California, New York.” We’re looking out across every single investment that exists, and it’s a very unique scattered market. And what is, what we think, is the most misrated bonds, the most mispriced bonds, many times agnostic of, again, maybe we have a little bit higher concentration in this state or in this sector, but we want to go out and allocate capital where we think it’s the most effective. I’m not just trying to track an index, that essentially, we think is not the correct way to be allocating capital anyway, in the municipal market.

[Rewey] So we’ve spent this time looking at the past five years, what can we expect five years from now?

[Foley] Sure. It’s been a, it’s been a fascinating time over the last year alone for the municipal market. So obviously COVID, and then we had the subsequent fiscal packages that came out. The last fiscal package was directly targeted, obviously, at state and local issuers of municipal bonds, and they received a pretty substantial amount of funding. But I think one of the things that really gets missed is that in all the previous packages, a lot of that money actually went to municipal issuers. So if you think about it, airports, hospitals, mass transit, in each one of those bills there were very large packages going to all of those issuers. And so when we add it all up, we’re looking at somewhere around $1.1 trillion, has actually flowed into municipal centric issuers, is what we would call it. Now, that being said, as we reflect back during the last year, the last 18 months, what we see is that, municipal issuers actually did not fare as bad as most people thought they might. They’ve actually fared quite well. And so, as we think about that, and what we’re seeing now is that the balance sheets of municipal centric credits have been bolstered fairly dramatically. I mean, so credit, I would say is probably one of the best, strongest points I’ve seen in my career. And so it’ll be interesting to see, kind of how that plays out over the next five years. I always joke that the best tailwind in the world for any asset class is higher tax rates, which directly affects municipal bonds. So anytime taxes go up, either at a state, city, or at the federal level, even 1%, right, that makes every dollar of your tax exempt income worth just a little bit more. So it should be a good next five years for the municipal bond market. And we’re excited to be a part of it.

[Rewey] Anything but a boring asset class.

[Foley] Yeah, anything but.

[Rewey] Nick Foley, thanks for joining us.

The opinions expressed in this video are solely the opinions of Segall Bryant & Hamill or an unaffiliated third party. You should not treat any opinion in this video as specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinions. The opinions expressed in this video are based upon information considered reliable, but completeness or accuracy is not warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can be guaranteed. Any and all information perceived from this video does not constitute financial, legal, tax, or other professional advice and is not intended as a substitute for consultation with a qualified professional. The opinions and statements are subject to change without notice and Segall Bryant & Hamill is not obligated to update or correct any information in this video. For illustrative purposes only.

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