Managing Municipal Bond Portfolios

It seems we cannot get enough of municipal bonds, taxable or tax free. The deals keep coming, the orders overflow, and some even get filled. Shampoo, rinse and repeat.

More demand than supply should keep bond prices buoyant. Unfortunately, financial products do not work that way. Wall Street’s job is to supply more when demand is high, and Wall Street is doing exactly that by creating more and more bonds (debt) to keep up.

Demand is high so municipal bond deals are large as well, some well over a billion dollars. According to Joe Mysak, Bloomberg’s long-time resident municipal bond market expert, this week marked “the 27^th deal of $1 billion or more, with overall borrowing accelerating at a torrid pace.” Amazingly, the municipal bond market remains around $4 trillion, the same as 2020, according to SIFMA website. Actual current figures are $4.1 trillion, the same as two years ago and barely higher than $3.9 trillion in 2019. So perhaps the $200 billion difference is due to larger deals! Shampoo, rinse and repeat as old bonds mature and they need to be replaced.

So how does one manage municipal bond portfolios? Largely they are managed with scale. This is where new deals like this month’s Eagle Mountain – Saginaw ISD featured bond comes into play. The best time, perhaps the only time, to buy a $5 million, $10 million, or $25 million piece is when they are first distributed. This is not new. The new issue market has been on the shampoo, rinse repeat treadmill for many years.

What has seemed to change is the scale of it all. Fewer Wall Street firms are in the game, but they are bigger firms looking to grow their share of the market. More importantly they are now looking to grow their share of municipals under management as well. Recurring ongoing fees, stretching years and decades into the future monetizes quite well for Wall Street firms.

Such large-scale management means everyone’s portfolios begin to look, and perform, like everyone else’s. Differentiation of portfolios is tough when you must buy hundreds of millions of dollars in bonds regularly or suffer the consequences of not being fully invested. Portfolio managers are at risk of not having their orders filled (when you want/need bonds) or at risk of being filled (when a volatile market ensues).

When scale is involved, it is hard to perform when your asset, quite frankly, is not performing. Looking at tax-free aggregate returns, using the Bloomberg Municipal Bond Index as our benchmark, has returned these total return figures: -2.44% year to date, +3.43% for one year, +1.57% for two years, -1.29% for three years, and +0.93% for five years. Compounding those returns over the past however many years you choose, does not look attractive. And these figures are before the management fees that Wall Street firms have as the basis of their business model.

Your business model should be different and here at The Select Approach^TM it is different. There is no way I could, or would want to, compete based on scale. This is not equity or private equity or corporate bonds or mortgages or treasury bonds that we manage. Wall Street banks and their competitors are applying scale to every market they touch. But these are municipal bonds!

The management of municipal bonds can be scaled…just look at the performance of the Bloomberg Municipal Bond Index. But good management, or better management, of municipal bonds would be to eschew scale. No, it would not work for Wall Street firms or their competitors, but we are looking out for ourselves, not for them.

The returns in your portfolios look nothing like the returns of the Bloomberg Municipal Bond Index. Look at your statements; look at your history. Not only are your returns better, but you are compounding them year after year, tax free.

Are we concerned about where the Federal Reserve may begin (or not begin) to cut rates? Are we adding duration because interest rates are higher than they were years ago? Are we worried about November? Have we added more high yield junk to our portfolio to boost returns or cover annual fees? Are you kidding me? We have built portfolios that perform. That is what we both expect.

Your municipal bond portfolio is truly unique. The only scale it has to it is the outperformance it has delivered to you, year in and year out.

Scale does work. Scale works in a bull market in which you sell your portfolio when the bull market ends. No Wall Street firm nor their competitors were willing to ever sell meaningful amounts. That day was March 2020 for treasury securities and a few months later for municipals. But you will not hear these firms ever mentioning that. Their vested interest (not yours) is to continue to monetize bond portfolios as their business model. Their economists will implore you to stay the course and if we just peddle faster (or get the Federal Reserve to cut rates, or elect the right people in November, or whatever) your portfolio will of course be just fine.

You have always had the other alternative available. I appreciate your trust in me. I appreciate the new money and referrals you bring my way. Your performance is a testament of how The Select Approach^TM works. It works for you.

Eagle Mountain – Saginaw Independent School District

Unlimited Tax School Building Bonds, Series 2024

Aa2 Moody’s Under AA Fitch Under (Aaa & AAA on PSF)

Due 8/15   Dated 6/15/24 Maturity 8/15/54

$145,380,000 Sold

Years   Maturity       Coupon        Yield*

1         2025             5.00%           3.23%

2         2026             5.00%           3.17%

3         2027             5.00%           3.06%

4         2028             5.00%           3.05%

5         2029             5.00%           3.00%

6         2030             5.00%           3.01%

7         2031             5.00%           3.02%

8         2032             5.00%          3.06%

9         2033             5.00%          3.05%

10       2034**          5.00%          3.04%

11       2035**          5.00%          3.08%

12       2036**          5.00%          3.12%

13       2037**          5.00%          3.21%

14       2038**          5.00%          3.26%

15       2039**          5.00%          3.29%

16       2040**          5.00%          3.38%

17       2041**          5.00%          3.49%

18       2042**          5.00%          3.56%

19      2043**           5.00%          3.61%

20      2044**           5.00%          3.66%

25      2049**           4.25%          4.26%

25      2049**           4.00%          4.26%

30      2054**           4.00%          4.34%

*Yield to Worst (Call or Maturity) **Callable 8/15/33

Source: Bloomberg

This is an example of a new issue priced the week of 6/24/24

Prices, yields and availability subject to change