Great Deals in Munis
When analyst Meredith Whitney predicted in December 2010 that legions of state and local governments would soon default on their debts, investors dumped municipal bonds in droves. Whitney’s forecast hasn’t panned out -- at least not yet -- but the people in charge of Managers AMG GW&K Municipal Bond Fund (symbol GWMSX) took advantage of the selloff to scoop up high-quality tax-free bonds at low prices.
Exploiting opportunities is a hallmark of the approach used by managers Nancy Angell, John Fox and Martin Tourigny. Among other things, the team buys bonds when interest rates are high and prices are low, and lightens up on positions when rates fall and prices rise (although Angell insists that the managers don't engage in market timing). It can also mean shifting the portfolio to sweet spots on the "yield curve" where they find bonds with the best yield-maturity combination.
The fund invests only in high-quality munis. Its average credit quality is double-A-minus, and it does not hold bonds rated below single-A. Moreover, the fund invests mostly in bonds issued by states and state agencies, seen as the safest type of issuers. As far as city and county bonds are concerned, "we invest only in a handful of the largest issuers," says Angell. "We avoid small cities and towns."
The fund is well diversified, with 91 bonds that span ten sectors and 22 states. Of the $65 million in assets, 24% is invested in general obligation municipal bonds and 69% is in essential-service bonds, including electric utilities, higher education, transportation and water (with 7% in cash).
Its current tax-free yield is 2.4%, which is equivalent to a taxable 3.7% for someone in the 35% bracket. Average duration, a measure of interest-rate sensitivity, is 6.1 years, suggesting that the fund would lose 6.1% if rates rose one percentage point.
Over the past year, the fund has returned 13.2%, compared with 10.3% for the average muni bond fund and 12.5% for the Barclays Municipal Bond index. Since it started in June 2009, the fund has returned an annualized 8.5%. Although it's only two-and-a-half years old and doesn’t have a long-term record, Angell and her co-managers do. Over the past ten years through December 31, 2011, a separate account for high-net-worth individuals managed in the same way as the fund returned 5.6% annualized, compared with 4.4% annualized for similar municipal bond funds.
Over the past three years, the separate account returned 9.2% annualized, compared with 7.0% for peer funds.
Angell thinks municipal bonds will stay in a tight trading range in 2012. Although she expects more muni bonds to be issued this year, Angell says she thinks there's enough demand to absorb new bonds coming onto the market without depressing prices. She also says that because of the weak U.S. economy, a modest pickup in municipal defaults is likely -- though nothing near Whitney’s doom-and-gloom forecast -- mostly for small cities and towns.
Angell sees states putting their fiscal houses in order. They've had seven consecutive quarters of rising revenues, with revenues up 7.3% in the third quarter of 2011. "People understand that munis are a high-quality asset class and that fears of default have been overblown," says Angell.Follow Jennifer on Twitter or become her fan on Facebook.