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Making Money in Munis

Munis may look attractive after all. Data suggests year-to-date through end of third quarter, the municipal market has experienced fewer than $1 billion in par value worth of defaults.

That’s heck of a lot better compared to $3.6 billion worth of defaults, about a quarter of what we saw in 2010. Keep in mind that both of these figures are a small fraction of 1% of the overall muni market.

So are the fears in the muni market overblown?

Megan McClellan, who’s the Head of Fixed Income at J.P. Morgan Private Bank (represents more than $140 billion in total client assets) and John Miller Co-Head of Global Fixed Income at Nuveen Asset Management both find value in certain areas. Miller expects to “see fewer municipal bond defaults this year.” McClellan believes “municipals will continue to appear cheap to U.S. Treasuries on a relative basis, assuming yields remain low.”

Defaults are coming down. That’s great news! Both experts attribute the decline in defaults to what the state governments have done a better job. States have managed to boost revenue and cut spending. Miller points out that issuance has “picked up to a large extent because interest rates have fallen this year, and the demand for municipal bonds has increased as the market has stabilized. This third quarter increase in supply comes off of a low base.”

Miller believes that this “a good time to invest in some specific segments of municipals are as follows: credits have made numerous fiscal adjustments which are positive for credit quality, yields remain higher than those of taxable U.S. Treasury debt, and credit spreads for bonds rated below AAA are significantly wider than historical averages, which creates opportunities for higher income.”

Miller has observed that BBB +/- rated municipals, which are investment grade and have experienced a very low historical default rate have lagged the municipal market rally. Miller said “their average credit spreads in this rating category are now 200 basis points (2%) above AAA municipal yields. We believe this range represents favorable risk/reward tradeoff. Local BBB rated story bond which is tax free federally and New York is the stadium which will be the new home for the Brooklyn Nets. The municipals are repaid by the property taxes on the development. Stadium is currently under construction.”

McClellan holds “short-duration, high quality municipals as the cornerstone of our fixed income portfolios.” However, given absolute low yields, McClellan is underweight the sector in favor of corporate credit. At these rate levels, McClellan recommends investors give their portfolio a tune-up. McClellan tells clients to “reduce duration; sell questionable credits; wait to average in cash for new supply at better entry points.”

Send us your questions on munis and tune at 430PM ET for our discussion on Closing Bell.

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