Record Municipal Fund Outflow Trend Abates; Higher Yields Following 2013

During the week ended January 15, 2014, investors placed net inflows of $103.3 million into the municipal bond funds macro-group. It was the first week of positive net flows into the segment since the week ended May 22, 2013 which was thirty-three weeks ago.

Municipal funds saw record net outflows of $64.2 billion during 2013 after a spate of highly publicized negative news emerged that impacted the normally placid asset class. News of Detroit’s bankruptcy filing, the fiscal challenges facing Puerto Rico–widely held by many state-focused U.S. municipal mutual funds because of its exemption from federal, state, and local taxes and its higher yields–drew investors’ attention toward issuer-specific risk.  Investors were also sensitive to the ongoing debate in many states–in particular, Illinois and California-over unfunded municipal employee pension obligations.

Municipal bonds generally sold off during 2013.  The Barclays Municipal Bond Index declined 2.55%. Most state municipal bond indices fared worse: the BofA Merrill Lynch California Municipal Index fell 5.19%, while the New York Municipal Index declined 5.78%. The SEC 30-Day yield, which is calculated net of fund expenses, within most of these municipal categories rose as a result. The average SEC yield in the Lipper California Municipal Debt Funds classification was 3.20% as of December 31, 2013, versus 2.27% a year earlier. New York Municipal Debt Funds’ SEC yield was 3.08% versus 1.98%, while that for the Lipper General & Insured Municipal Debt Funds classification was 2.87% compared to 1.86% on December 31, 2012.

The allure of these increased tax-free yields–the average SEC yield in the Lipper High Yield Municipal Debt Funds classification was 96 basis points higher at 4.36% at the end of 2013 compared to 3.40% at year end 2012–combined with the lack of any new surprises in the municipal finance space and concerns about the short-term valuations and prospects for both fixed income and equities could all have likely helped to contribute to the uptick in flows.