From humble beginnings in 1812 when the first recorded tax-exempt bond was issued to finance a canal project in New York, the municipal bond market in the United States has quite literally grown up with our nation. The basic concept has endured now for over 200 years: qualified state and local government issuers borrow funds to build public schools, roads, hospitals, water systems, and other public purpose projects by issuing bonds. Those bonds are purchased largely by the investing public, and the interest income on those bonds is (in most cases) exempt from federal income tax. Funds to repay the debt issuance are generated by a combination of property taxes, sales and use taxes and a host of other assessments at the state and local level. Issuing districts get to tap reliable funding sources at attractive interest rates, and investors get tax-free income…a virtuous circle designed to provide stable ongoing flows of capital for important public sector infrastructure projects.
A Highly Diverse and Opaque Market
Today, there are some 70,000 issuers of municipal bonds in this country, and over one million outstanding muni bond issues, making this corner of the U.S. capital markets incredibly diverse, dynamic and yet at the same time, fragmented and a bit opaque to the traditional retail investor. At Segall Bryant & Hamill (SBH), we have developed a specialty in municipal bonds that fits perfectly with our investment culture. The high degree of knowledge and insight required to successfully manage municipal bonds calls for exactly the kind of in-depth fundamental research we do at SBH. Our team of municipal bond specialists dives deeply into credit fundamentals, picking and choosing carefully among the large pool of outstanding bonds to isolate the most attractive bond candidates at the appropriate level of risk and return.
The Importance of Liquidity
Liquidity is enormously important. Most municipal bonds—particularly the smallest issues which might be just $15 to $20 million total issuance and perhaps $250,000 per maturity—rarely trade in the secondary markets, if at all. To buy and hold some of these credits, we believe you must be highly confident of the long-term stability of the issuer. Even larger, more seasoned issues might not trade daily or even weekly. There have been periods of time (notably the Great Recession and Global Financial Crisis of 2008-09) when the creditworthiness of some state and local governments plummeted. Outright defaults on muni bonds are rare, but they do happen, and troubled bonds are often restructured in ways quite unrewarding to original bondholders. Thus, for us, the “Mantra in Munis” is simple: do your homework, no short cuts, clip your interest coupons, and get your par value back at maturity.
Investing in Today’s Municipal Market
The times in which we live now are creating potential challenges in some municipal bond issuers tied to higher education and health care. The COVID pandemic and the large-scale behavioral changes it has wrought once again shine a spotlight on the importance of fundamental research. Our municipal bond team is applying extra vigilance today to screen new bond purchases and monitor the ongoing metrics of portfolio holdings. We are proud of our efforts in this important sector of the investment landscape, and we welcome your ongoing interest in our work here.
Opinions expressed are current opinions as of October 2020. The opinions expressed are solely the opinions of Segall Bryant & Hamill. You should not treat any opinion as specific inducement to make a particular investment or follow a particular strategy, but only as an expression of the manager’s opinions. The opinions expressed are based upon information the manager considers 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 article does not constitute financial, legal, tax, or other professional advice and is not intended as a substitute for consultation with a qualified professional. The manager’s opinions and statements are subject to change without notice and Segall Bryant & Hamill is not obligated to update or correct any information in this article.