Investors continue to stuff municipal bond mutual funds with cash, supporting bond prices even as by some measures they are nearly as expensive as they have ever been.
Early last month, it appeared fund flows had finally slowed down. Cash was landing in municipal funds at a rate of less than $1 billion a week for the first time in six months.
Now it appears that may have just been a blip.
Investors have entrusted $1.52 billion a week for the last four weeks to municipal funds, according to Lipper FMI, the most robust pace of inflows since October.
The industry's 592 funds collected $69 billion in new money from investors in 2009, according to the Investment Company Institute, easily a record.
Based on numbers from Lipper, municipal bond funds have already collected $12 billion in new money so far this year. The current pace of inflows would have been a record before last year. The latest torrent of cash comes despite most traditional measures showing municipals are expensive.
The S&P National AMT-Free Municipal Bond Index, which measures total returns on municipals, is already up 1.7% this year after climbing 12.2% last year. The yield on the 10-year triple-A muni has slid 20 basis points since the end of January to 2.8%, a yield higher than all but 32 trading days since Thomson Reuters started keeping track in the early 1980s. The two-year triple-A municipal yield is 65% of the two-year Treasury yield. The average since 1990 is 78%.
Cash is Key
Asked what the source of this strength is, George Strickland, managing director and co-portfolio manager at Thornburg Investment Advisors, volunteered a single word: "Cash."
At the apex of the financial crisis, households had more than $7.9 trillion squirreled away in short-term safe havens like bank deposits and money market funds, according to the Federal Reserve. The Fed is doing everything it can to keep returns on these instruments minimal to encourage people to invest their money and stimulate the economy. Short-term Treasury bill and bank yields are well under 1%, and according to iMoneyNet, the average tax-free money market fund yields 0.02%.
Those paltry returns are coaxing money out of short-term safe havens and into assets that can generate better returns, Strickland said. Since the beginning of last year, investors have yanked more than $100 billion from their tax-free money funds, according to ICI.
However, rather than flowing into equity mutual funds, much of that cash is likely ending up in muni mutual funds, Strickland said. "It's just plain old cash hitting the market," he said.
Strickland, who helps manage six muni funds, including the $2.92 billion Thornburg Intermediate Municipal Fund, said the wave of cash has rendered municipals too costly, and the market is likely due for a pullback.
When asked how a municipal fund manager deals with a never-ending flood of new cash from clients at a time he thinks municipals are too expensive, Strickland volunteered another single word: "Carefully." Strickland said he is keeping more of his funds' assets in cash and moving into more liquid paper to shelter the bonds from what he foresees as a coming correction.
The municipal market has become so accustomed to regular slugs of cash from mutual funds that even a modest slowdown in flows would likely hurt the market, he said. "We've stretched valuations too much now, and the market's set up for a tumble," Strickland said, stressing that he nonetheless believes the long-term outlook is still strong.
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