by Tom Roseen.
Municipal bond funds have struggled so far in 2022, witnessing record outflows through the Lipper fund-flows week ended Wednesday, June 15, and posting an average year-to-date market loss of 9.98%—their largest decline of any full-year return dating back to 1992 when Lipper began tracking weekly net flows. Year to date, municipal debt funds handed back a net $72.5 billion, eclipsing the full-year record net outflows seen in 2013 of $64.2 billion.
As inflationary concerns escalated during the fund-flows week and the likelihood of a 75-basis-point (bps) interest rate hike became more likely, the broad-based indices were hammered as investors weighed the possibilities of the U.S. economy experiencing a hard landing and ending up in a recession.
For the flows week, the 10-year Treasury yield rose 30 bps, closing out the week at 3.33% after hitting a closing high of 3.49% on June 14—its highest close since April 14, 2011—after the Federal Open Market Committee raised its key lending rate by an aggressive 75 bps.
The writing was on the wall after the consumer price index (CPI) report, released earlier in the week, showed U.S. inflation increased 1% in May, outpacing analyst expectations of 0.7%. The year-over-year rise of 8.6% was the highest since 1981. The producer-price index provided additional confirmation that inflation may persist, and the Fed would need to be aggressive, with the price of wholesale goods and services jumping 0.8% in May and final demand prices moving up to 10.8% for the most recent 12-month period.
For the most recent fund-flows week, municipal debt funds suffered a net outflow of $5.6 billion, their third largest net outflows on record and the largest since March 25, 2020. For the week, they posted a 3.01% decline, posting their third largest weekly market decline since 1992. With the Federal Reserve Board signaling its intention to hike rates since the beginning of the year, it was not surprising to see that the group had seen 20 weeks of net outflows in the last 24.
The 15 consecutive weeks of net redemptions seen recently this year is the longest string of outflows witnessed since the 33-week net-redemption run that ended on January 8, 2014. Recall in 2013 that investors fell victim to taper speculation and negative press that hounded Detroit and Puerto Rico issuers, both going through default concerns. The one similarity is that for both time periods, yields started out relatively low and the potential for price appreciation was/is minimal.
Like then, taxable investors will now have to reassess why they are using municipal debt funds in their portfolios—diversification and tax-free income. While the 40-plus-year bond bull market is over and the market correction and weak performance is painful, the opportunity to invest money at higher yields can be attractive—but investors will need to remain cautious as they look for attractive points of entry. Despite the Fed’s aggressive interest rate hike in June, some pundits feel the Fed may still be a little behind the curve and volatility is likely to remain ever present as municipal yields stay range bound and the new issue calendar is muted.
As we have outlined before, the dichotomy between mutual funds and ETFs, however, is very pronounced in the municipal debt funds space. Municipal bond ETFs have attracted a net $10.8 billion year to date, while their conventional municipal bond fund brethren have handed back some $83.3 billion. And while we are uncertain if investors are really focused on the passively managed aspects of municipal bond ETFs, they may be selectively using ETFs for added tax efficiency via in-kind redemptions, relatively lower expenses, and ease of entry and exit throughout the day. So, some investors may be turning toward ETFs to test the waters for attractive points of entry. I should mention though that the assets under management for the two structures are quite different, with conventional municipal debt funds total net assets hovering around $803.7 billion and their ETF counterparts coming in at just $86.6 billion.
Check out more weekly flow trends here.
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