Tuesday, July 23, 2013


Over the past few months, munis have a hit hard, very hard. Even after the mild recovery since the end of June, index funds such as MUB (duration 7.17 yrs, distribution yield 2.97%) are down in excess of 7% YTD. High-yield munis, HYMB (duration 12.02 yrs, distribution yield 5.89%), are taking it even worse with a YTD drawdown of almost 12%. In a perfect storm of rising yields, illiquidity, high redemptions, and a default from Detroit to boot, munis are facing considerable challenges. HYMB, especially, is exhibiting considerable discount to NAV at the 3-5% level. Unfortunately, as others have noted, for highly illiquid assets such as muni bonds, the market price might actually be more accurate than the NAV. That said, even with the Detroit bankruptcy, which has been thrown back into court, the credit impact on HYMB should be muted as Detroit only comprises 1.33% of NAV and even all of Michigan only 3.53%. There is, however, the risk of other municipalities defaulting, but that risk has been there for a while. Note that muni bonds typically have high recovery rates (as high as 68%). The remaining headwinds of rising rates and redemptions will likely be challenging enough for the muni market. As the economy recovers and state coffers get replenished, the credit spread ought to tighten, but whether enough to counter the effect of rising rates is another question.

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