MacKay Shields’ team of municipal managers has taken to calling 2015 “The Year of Transition to Active Management.”
As market volatility and rate uncertainty continues, the MacKay Municipal Managers believe there is a positive trend toward portfolios taking an active approach to municipal bond investing.
The MacKay Municipal Managers, co-headed by John Loffredo and Robert DiMella, released this month their annual views and insights for the municipal market.
With reportedly more than 50 years of combined experience in active management, the group has outlined the top five muni bond trends for the upcoming year.
1. Demand for municipals remains high
The MacKay Municipal Managers team predicts that the demand for municipals will remain high and liquidity will improve — largely thanks to certain institutional clients, including insurance companies, continuing to add municipals to their core portfolios.
“These institutions, with varying tax profiles, will likely view municipal bonds as a compelling investment solution that offers attractive, absolute income streams,” say the municipal managers in a statement.
The MacKay Municipal Managers also believe that proprietary trading desks will resurface, as a result of favorable market conditions and regulatory developments — and, therefore, they say “liquidity will improve on the margin.”
2. Yield curve flattening
“We expect a flattening of the yield curve to cause disruption in the market and spread widening among high-grade bonds on the short/intermediate part of the yield curve and, as a result, we believe this segment of the market should be avoided in 2015,” the managers say in a statement.
AA and AAA-rated municipal bonds pose a particular risk, as they have higher correlations to Treasury securities.
“AA and AAA-rated municipal bonds in the three- to seven-year maturity range have higher exposure to potential interest rate hikes by the Fed than most other segments of the municipal market,” according to the municipal managers. “This is due in part to the expensive nature of the high grade, short/intermediate part of the municipal market.”
Thus, the managers’ preferred portfolio structure is to focus on cushion bonds, aka high coupon/premium bonds, as a way to get defensive on rates without sacrificing income.
“We believe this will cause actively managed portfolios to outperform passive municipal bond ladders in terms of total return and current income,” they state.
3. New bond issuance surprises on the upside
Although the managers project new bond issuance will surpass consensus and exceed $375 billion, they also believe that net new supply will remain negative for the fifth year in a row. And accordingly, the overall municipal market will continue to shrink.