In March 2020, the COVID-19 crisis caused dislocations across world financial markets. The municipal market was not sheltered from this chaos. At the end of February, tax-free yields were sub-1% out to 11-year maturities. In mid-March, municipal bond prices plummeted, and index yields increased daily by 40-50 basis points. From March 11th to March 20th, the 10-year AA-rated municipal benchmark yield rose from 1.32% to 2.92%.
Mutual funds and exchange traded funds (ETF’s) were the cause behind the sell-off. Funds were significant net sellers during this period due to investor redemptions. These funds were forced to sell their underlying holdings in order to meet redemptions at irrationally low prices/high yields. ETF NAV values also plummeted, adding to downward pressure on bond prices. Bond fund and ETF products were caught in a liquidity trap – supply hugely outweighed demand – heightening the trading mismatch between the investment vehicles and their underlying assets. Investors in these vehicles realized significant losses during this period.
The selloff was also exacerbated by two market dynamics occurring within fund and ETF products that had been developing since the previous crisis, consequences of the low rate environment. Many tax-free fund and ETF products increased their exposure to lower quality municipal credits in order to increase portfolio yield. These types of credits are much more sensitive to the ongoing economic crisis compared to public purpose municipal general obligation (GO) or essential purpose revenue issues. Secondly, many fund and ETF products had increased their interest rate risk by increasing duration to conform to industry benchmarks.
In contrast, the separately managed account (SMA) structure proved its worth again. Our Bernardi Asset Management (BAM) tax-exempt strategies outperformed. Our SMA clients were not forced sellers and BAM’s strategy of allocating to high grade GO and essential purpose revenue bonds were two of the primary reasons. Ultimately, the SMA structure allows for greater control over portfolio activity and avoiding being caught up in the “herd” of market activity. Our BAM strategy returns below reflect this dynamic.
Below are returns of two BAM tax-free strategies compared to some of the larger mutual fund/ETF comparable alternatives. BAM’s High Income Municipal strategy received PSN’s Top Guns award for having one of the top ten returns for the quarter in its respective category.
|Municipal Strategy/Product||1 Month||YTD||1 Year|
|BAM Tactical Ladder||-0.02%||0.61%||3.37%|
|BAM High Income||-0.58%||0.33%||3.89%|
*Source: Bloomberg. Based on share price return. No dividend reinvestment. Returns as of 4/30/2020