The low risk profile, low correlation to other markets and, for US investors, the tax advantage, have all led to increased asset flows into New York Life Investments’ MacKay Municipal Managers, the active management team behind IndexIQ’s two muni ETFs.
The team recently celebrated its 10-year anniversary and now manages USD42 billion in municipal assets.
David Dowden, portfolio manager at the firm, says: “We are very excited about this. When we came out with these products the ETF space was historically where the notion was to be passive and index oriented and that works great in very efficient markets like the stock markets or the commodities markets but in the muni bond market, which is a textbook inefficient market, the notion of an index based aproach begins to break down.
“We launched ETFs because we had the capability of managing them actively which adds value and a distinct difference where we could bring our active expertise.”
Municipal bonds are loans to local governments and issued at all levels of government, from cities to states or countries. The interest on the bond is tax-free in the US and they are both investment grade and high yield.
Dowden’s fellow portfolio manager John Lawlor says: “Investors are reaching for yield because you are late cycle in the equity market and they are making defensive moves towards fixed income.”
Year to date, open-ended municipal bond mutual funds have seen approximately USD53 billion of inflows.
“There are two primary drivers,” Dowden says. “One is that investors are getting a sense of the impact of the cap n state and local tax deductions in the US. Secondly, as soon as it became apparent that the Fed was altering its stance and potentially going into more of an accommodative position, investors who had been anticipating higher rates viewed that as not going to happen so put their money back in the market.”
Year to date, close to USD14 billion has flowed into MacKay’s muni ETFs, which were launched in the fall of 2017.
Dowden says: “Muni bonds investors come to the market in one of several major formats: the first is the open-ended mutual fund market, next is ETFs. This is the newcomer from a product standpoint. Historically people have invested in the bonds directly in a brokerage account as well, but a more nuanced approach is that you have the bonds in your account but they are being professional managed. Investors come to our market in multiple ways.”
While the pair believe that taxes should never be a primary reason for investing, the appeal of muni bonds lies in an array of factors including the credit quality of the bonds with muni bonds skewed towards the higher end of the investment grade scale.
The most popular muni bonds are based on tax backed strong revenue sources such as a toll road, property or water and sewage systems, particularly where there is a monopolistic situation.
“Domestic investors like that muni bonds have a low risk profile low correlation in terms of price movement relative to other sectors of the bond market and then the tax exemption,” Dowden says. “Foreign investors look at risk adjusted returns and like the monopolistic factors, the non-correlation and the high quality. They look at them as an excellent opportunity to diversify in fixed income in a portfolio laden with corporate bonds.”
Lawlor explains that it’s the 10th anniversary of NY Life’s investment boutique’s muni bond team and between them the team of portfolio managers has been in the business for an average of 30 years. MacKay started out with assets of just USD250 million and have seen exponential growth over that 10 years to USD42 billion.
Part of the muni bond market has a credit overlay coming from monoline or single line insurance companies who apply a policy to the bond, effectively guaranteeing timely payment of the principal and the interest. For an individual investor in the US, the insurer is effectively stepping between the issuer and investor and doing all the credit research work.
“They are so confident in their abilities that they guarantee what will happen which gives investors’ confidence, which leads to better liquidity and price discovery, which is why we launched MMIN,” Dowden says.