Municipal portfolio managers say retail investors are turning to tax-exempt bond funds because they see them as a relatively safe harbor in stormy seas.
As moms and pops have gotten older, they’ve started looking for income. They can’t find it in cash at near 0% interest rates, and they’re growing tired of the stock market’s persistent volatility.
What’s more, portfolio managers note a disconnect from past markets for retail investors who are still looking for a 5% coupon and are finding prices on these bonds in the lower interest-rate environment selling at steep premiums to par.
And because that’s proving to be a psychological barrier to retail, which has long favored discount bonds or par bonds, brokers recognize that bond funds might be the easier sale, according to Todd Curtis, a senior portfolio manager at Aquila Funds.
“Brokers don’t have to convince people to buy something where they pay more for it than they know that they’re going to get back,” he said, referring to retail investors’ reluctance to pay a price above 100.
Investors in funds are still exposed to interest rate risk.
Retail investors daunted by high prices and credit fears have pulled back a bit from individual bonds. Instead, they’re interested more in separately managed accounts, mutual funds and other managed solutions.
The retail segment has typically accounted for about 70% of municipal bond sales. Traditionally, retail investors have favored individual bonds over bond funds, said Josh Gonze, a portfolio manager and managing director at Thornburg Investment Management.
Almost two years ago, the warnings of a prominent Wall Street analyst frightened moms and pops with predictions of municipal defaults. That prompted a stampede of investors to pull money out of muni bond mutual funds between mid-November 2010 and early June 2011, typically by more than $1 billion a week. In the week of Jan. 19, 2011, investors in weekly reporting funds withdrew more than $4 billion.
The reversal has been striking, as well. As the market’s health returned, so have the inflows to muni bond funds, to the tune of 30 weeks out of the past 33. Retail investor confidence in the market and muni bond funds has revived, as well.
Another factor retail investors might have considered was total return. According to Janney Capital Markets, municipals boasted a 10.7% total return for 2011, better than that of their big brother, Treasuries. But even with the market’s sounder fundamentals today, few analysts would anticipate a repeat performance this year.
Ultimately, though, retail investors care about maximizing income in a relatively safe asset class in the generic part of the market, and not so much total returns, said Peter Hayes, head of municipal bond trading at BlackRock.
“When you get a year like 2011, where total return was such a big part of the overall performance of municipal bonds, investors might have placed less emphasis on income,” he said. “They say it’s chasing returns. That’s not largely the case, but people sometimes forget about the reason they invest in munis, and why investors always have, and that’s because of income. In munis, you have an asset class that is in some ways the next safest to U.S. Treasury debt.”
Muni bond funds help moms and pops get the diversification they need better than individual bonds, considering the historically low absolute level of triple-A muni yields, market professionals say.
Rob Williams, a muni expert and director of income planning with the Schwab Center for Financial Research at Charles Schwab, said he’s seen a little bit more hesitancy on the part of individual investors adding money to buy bonds on their own. They are putting more money into mutual funds, he added, and turning some of the decision-making over to managers.
In addition, it’s often difficult to find bonds that fit their parameters, said Philip G. Condon, a managing director and head of municipal bond portfolio management at DWS Investments.
“If someone’s going to put $50,000 to work,” he said, “it’s a lot easier to find the appropriate muni bond fund than trying to go out and find a block of bonds that you think might be the right block for you.”