INSTITUTIONAL INVESTOR COMMENTARY
MUNI
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HY
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ABS
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CMBS
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RMBS
DECEMBER 2013
Municipal Market Outlook INVESTMENT PROFESSIONALS B. SCOTT MINERD Global Chief Investment Officer ANNE B. WALSH, CFA Assistant Chief Investment Officer, Fixed Income JAMES PASS Senior Managing Director, Portfolio Manager ALLEN LI Director, Portfolio Manager CHRIS RANDALL Vice President, Trader DAVID A. STONE Analyst, Credit Research KELECHI C. OGBUNAMIRI Vice President, Investment Research
The structural issues that have plagued the municipal sector for decades have received widespread media coverage over the past three years. The severity of pension shortfalls, the sector’s worst kept secret, finally came to light and individual investors responded by withdrawing $50 billion from municipal bond funds in 2013. Despite the significant obstacles facing specific issuers, such as Illinois, Puerto Rico, and Detroit, these isolated instances are not representative of the highly diverse $3.7 trillion municipal market. Current sentiment is reminiscent of December 2010, when dire forecasts of widespread defaults resulted in $16 billion of municipal bond fund outflows over a two-month period. At the time, we stated that the “blanket misperception of credit deterioration across the asset class has led to wider spreads for even the most creditworthy municipal debt issuers.” (See "Opportunities in Municipal Finance" Q4 2010) Actual default activity paled in comparison to the magnitude predicted, and market hysteria subsequently abated. The sector produced 11 percent annualized returns in 2011, outpacing both equity and corporate bond markets. We believe current headline risk has created a similarly attractive opportunity for fundamentally driven investors. REPORT HIGHLIGHTS:
• With $50 billion in capital withdrawn from municipal bond funds this year, individual investors are clearly operating under a “sell first, ask questions later” mentality, similar to what occurred following Meredith Whitney’s now infamous prediction of financial Armageddon in the municipal market in late 2010. • The financial media’s fixation on troubled issuers has created the perception that fiscal conditions are deteriorating across the United States. In reality, the overall fiscal picture is improving as U.S. state and local tax revenues in the second quarter of 2013 rose 8.9 percent, the 14th consecutive quarter of growth. • We see attractive opportunities in areas of the market recently vacated en masse by investors, such as intermediate to longer-duration bonds, and select revenue bonds of distressed cities. For investors with the ability to decipher the complex municipal market, we believe current market dislocations offer the opportunity for attractive returns.