In this quick post we highlight how attractive Municipal Bond valuations are in the current environment.
The S&P Municipal Bond Index yield is close to its 10-year high.
Muni/Treasury Ratios have risen sharply and are near their highs outside of exceptional periods.
Sub-AAA rated Muni bond credit spreads have risen as well.
Finally, tax-exempt CEF discounts are trading at wide levels historically.
Based on these themes, our conclusions are that, first, duration assets like munis remain attractive given the back-up and apparent stabilization in Treasury yields. Two, municipal bonds are predominantly higher-quality assets which should also hold up well in case a hard landing does arrive. Three, for investors attracted by high-yield Munis, the valuations in that sub-sector are finally attractive to start adding. And four, muni CEF discounts remain at attractive levels historically.
At the same time, investors should be prepared for continued trimming of muni CEF distributions. That is simply the price of admission. Investors who wish to minimize the potential for cuts should look out for funds that have front-run the cuts by cutting this year and/or whose distribution coverage is well north of 100%.
To reflect the evolution of these themes as well as the pricing in the Muni fund market we have made one change in our Municipal Income Portfolio. Specifically, we have reduced our allocation to the MainStay DefinedTerm Municipal Opportunities Fund (MMD) – we added in mid-April. The fund has outperformed the broader sector as well as the Municipal 2030 Target Term Trust (BTT) that we used as the source for the rotation.
The chart below plots the discounts of MMD, BTT as well as the Municipal sector, highlighting that the MMD discount has tightened much more quickly, significantly outperforming both BTT as well as the sector.
The chart below shows that MMD was trading at a 3% premium relative to the sector which we viewed as attractive and it is now close to a 9% premium relative to the sector which we consider excessive and would wait for a better entry point in the future.
In exchange, we have added to the BNY Mellon Municipal Bond Infrastructure Fund (DMB) trading at an 11% discount (vs. 6.6% sector average) and a 5.75% current yield (vs. 5.51% sector average). The fund has a revenue bond focus with significant infrastructure exposure. For this reason, it has a higher unrated bond exposure at around double the sector average.
DMB also has a more modest duration profile at 4.6 than the broader sector which is one reason it has held up relatively well this year, outperforming the sector by 3% year-to-date in total NAV terms.
DMB has put up stronger historic returns than the broader sector, outperforming it by 0.7% per annum over the last 5 years in total NAV terms.
Its valuation also looks attractive relative to the sector as the following chart shows – the discount differential is close to the widest of the last 5 years. Finally, the fund’s distribution coverage is around 99%.
Thanks for reading.
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