From Turbulence to Opportunity for Municipals

(Mike Spitz) Thank you everybody for joining us today. My name is Mike Spitz, Director of Distribution and National Accounts, here at Segall Bryant & Hamill. And joining us is Nick Foley, who’s our Head of Municipal Management, here at SBH. And this is, From Turbulence to Opportunities in the Municipal Market. Nick, thanks for joining us.

(Nick Foley) Absolutely.

(Spitz) Let’s dive right into it and just talk about municipal market performance the first quarter of 2022. I think it was the worst quarter on record for municipal bond performance. If you want to discuss, just briefly, what contributed to that negative performance in the municipal market? And do you think that we’ve kind of reached the peak or the end of the pain in the municipal market?

(Foley) Yeah, absolutely. Yeah. It’s been just a brutal year across all of fixed income. Absolutely. And it’s hard to say obviously where, you know, when markets have bottomed or how they’re going to turn, but we do believe that we’ve likely born the brunt of price losses. And there’s a couple reasons we say that. One is that, fixed income is actually somewhat unique in that, we call it, “A self-healing asset class,” where again as you have price losses, that means that yields are actually rising on the bonds that you get. And so these higher yields and higher income can actually offset future price moves and price losses, as well as future volatility. So we think that, although obviously, it has been a brutal year, we think that it is interesting going forward, especially in tax exempts where $1 of income, obviously because it’s exempt, is worth more than $1 of price scan.

(Spitz) Thanks, Nick. Obviously, performance and flows tend to move in lockstep with each other. So after 2021, you saw a record amount of inflows into the municipal and pretty much across the fixed income market as a whole. Then looking at this year, we made it two weeks into the new year of positive flows and then you saw a complete reversal of that. What do you think caused the reversal and flows, and what accelerated that cause, I should say, in outflows? And do you think that this opens the door to any opportunities for you as a municipal manager?

(Foley) Yeah, absolutely. Yes. It’s a great question. So flows have been incredibly important this year. We’re actually undergoing what is our largest outflow cycle nominally, that we’ve ever had a municipals. You know, we should caveat though that, obviously, the municipal market has grown pretty significantly. And so, the percentage of the total asset class in outflows is actually a little bit different number, just to put things in perspective, but these outflows make liquidity really challenging. Obviously presents a number of different challenges, but on the other side, it also creates lots of opportunities if you’re an opportunistic manager. So we see valuations fluctuating. We see, in certain time periods during the market and liquidity profiles in the market, that different bonds can trade all over the place. So if you’re actively looking and you’re in the markets every day, like we are, and you have a firm basis of what you think valuation and credit are, some days, you know, you can really write your own ticket, as far as buying a bond at a certain level that you’ve waited years, essentially, to buy at that price.

(Spitz) Let’s move over to, I think, what’s on every fixed-income investor’s mind right now, be the Fed and the rising interest rate environment that we’re now in. So as investors continue to be concerned about, elevated inflation, and the effects of the Federal reserve on raising interest rates, historically, how have munis performed in past Fed hiking cycles?

(Foley) Yeah, definitely. Top of everyone’s mind for sure. Top of our mind, obviously every day. One thing that’s important to note, and we’ve seen this confusion a little bit, so just to clarify, but the treasury market and markets as a whole, are pricing in, again, what they forecast out, the Fed is going to do. And so there’s this, I’ve heard this belief that, bonds will really start to underperform as the Fed hikes. That’s not totally correct that, again, the market is already pricing in a certain number of hikes, and so fixed-income, stocks, other asset classes have already reacted to what they think the market’s going to do. So the bigger question really just becomes, versus what the market has priced in, what will the Fed eventually do? One really unique, interesting thing about munis is that the last four times rates were raised, it’s possible, or municipal bonds have shown that they can have limited downside and even gains during Fed hikes. Munis have historically outperformed treasuries and corporate bonds in prior periods of rising rates. And as we look out across the actual credit spectrum municipals, we’ve seen that the Federal pandemic relief has truly strengthened the credit profile of lots of these municipalities. And so we’re actually quite optimistic on how this will play out, definitely from a credit standpoint. And we feel that, again, due to the forward looking nature in the markets that, as we said earlier, a lot of the price losses have already been born at this point.

(Spitz) Yeah, it’s an interesting dynamic. Municipals have never been as healthy as they are now, yet we’re facing one of the worst performance periods that we’ve seen. Let’s end it with this, Nick… We kind of alluded on it and touched it on it earlier, but just, opportunities. You, as a municipal manager, and the strategies that you run across the curve, where is it that you’re seeing opportunity across the curve, whether it be certain credits, certain maturities, et cetera?

(Foley) Yeah. Yeah, we think of ourselves as an opportunistic manager. So we look, we don’t just have some set playbook or some set code that we just do over and over and over again. We really assess everything that’s going on across the entire market, across all sectors and say, “Where do we think the market is mispricing risk?” Right? So during very, very strong periods, obviously, that can be really challenging. Like last year, when there, essentially, were not enough bonds to buy and there was more money than bonds. It was, it could be really challenging to find opportunities. Now this year, flip that on its head, and it’s been extremely interesting to see fluctuations in various credit spreads, credit spreads across different sectors. And what we’re seeing is a wide range of really interesting opportunities over the short, medium and long term. So we’re seeing situations where we can enter into credits for say, 10 years, at what we think is an extremely attractive after-tax level. And we think that munis, as we look at after-tax yields, are actually going to be really competitive with a wide variety of asset classes, not just fixed income. So from an opportunity set standpoint, as we think about the last couple years and where we’re at today, it’s just night and day, as far as where valuations and spreads and yields are in.

(Spitz) Got it. No, thanks, Nick. Sounds like a good opportunity, at least that we haven’t seen in many years in the municipal market. With that, I want to thank everybody for joining us for today’s podcast. If you have any questions, please feel free to reach out to your Segall Bryant & Hamill sales contact, and we hope to see you on our next podcast. Thank you.