Recent price weakness has opened up avenues for return potential.
The first half of 2022 was particularly painful for fixed income investors, as bonds failed to provide the diversification benefits many had come to expect in periods of equity market turbulence. Municipal bonds were not immune, as the Bloomberg Full Market Municipal Index dropped about 9% through June. (Shorter maturities tended to fall less—about 5.5% for five-year bonds.) However, although the setbacks were meaningful, we see a silver lining in recent events: higher yields and renewed opportunity to potentially add value through active management.
Last year, when central banks were cocooning financial markets from the pandemic, yields were close to zero and it was very difficult to gain advantages from fundamental insights—as even questionable issuers saw their valuations lifted by easy monetary policy. However, given the sizable upward move in rates this year, combined with cheapening valuations, absolute yields across fixed income are much higher than in December. We believe this is providing opportunity in various sectors, including investment grade corporates, high yield—and municipal bonds.
As of midyear, the average yield on AAA 10-year municipal bonds was more than double the level seen at the start of the year. These yields represent about 90% of those available from corresponding Treasuries, compared to about 70% on January 1—meaning that the federal tax exemption on municipal income is now close to free.
Beyond yield, however, we believe conditions are ripe for active management in municipals. Although credit quality remains strong, dealers of new financings are eager to move product and are willing to make concessions to find buyers. In secondary markets, investor outflows are creating many “forced sellers” who otherwise might rather hold onto bonds until recovery or maturation.
In our view, active managers have the potential to capitalize on these dynamics, as well as shifting market views on the economy and Federal Reserve policy. Rather than a static market, we are seeing a rapidly evolving one, rife with uncertainty and therefore opportunities to potentially add value through fundamentally driven research and trading—as well as, where possible (in the case of separate accounts), “swapping” securities to capture losses for tax purposes.
From a risk perspective, municipal credit quality tends to be like a slow-moving ship—as tax-base deterioration for local credits usually lags relative to declines in the broader economy. State governments can be more cyclically sensitive, and we will be watching closely to see how their fortunes evolve.
In the meantime, we remain somewhat cautious on interest rates, but overall are finding ample opportunities as we sort through a newly dynamic marketplace.
Upward Move in Yields Across Maturities
AAA Municipal Bonds
Source: Bloomberg. As of June 30, 2022. Nothing herein constitutes a prediction or projection of future events or future market behavior. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Indexes are unmanaged and are not available for direct investment. Investing entails risks, including possible loss of principal. Past performance is no guarantee of future results.
This material is provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. This material is general in nature and is not directed to any category of investors and should not be regarded as individualized, a recommendation, investment advice or a suggestion to engage in or refrain from any investment-related course of action. Investment decisions and the appropriateness of this material should be made based on an investor’s individual objectives and circumstances and in consultation with his or her advisors. This material is not intended as a formal research report and should not be relied upon as a basis for making an investment decision. The firm, its employees and advisory clients may hold positions within sectors discussed, including any companies specifically identified. Specific securities identified and described do not represent all of the securities purchased, sold or recommended for advisory clients. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. Neuberger Berman, as well as its employees, does not provide tax or legal advice. You should consult your accountant, tax adviser and/or attorney for advice concerning your particular circumstances. Information is obtained from sources deemed reliable, but there is no representation or warranty as to its accuracy, completeness or reliability. All information is current as of the date of this material and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole. Third-party economic or market estimates discussed herein may or may not be realized and no opinion or representation is being given regarding such estimates. Neuberger Berman products and services may not be available in all jurisdictions or to all client types. The use of tools cannot guarantee performance. Diversification does not guarantee profit or protect against loss in declining markets. As with any investment, there is the possibility of profit as well as the risk of loss. Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Unless otherwise indicated, returns reflect reinvestment of dividends and distributions. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.
This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed or any historical results. Nothing herein constitutes a prediction or projection of future events or future market or economic behavior. The duration and characteristics of past market/economic cycles and market behavior, including length and recovery time of past recessions and market downturns, is no indication of the duration and characteristics of any current or future market/economic cycles or behavior.
A bond’s value may fluctuate based on interest rates, market conditions, credit quality and other factors. You may have a gain or loss if you sell your bonds prior to maturity. Of course, bonds are subject to the credit risk of the issuer. Neither Neuberger Berman, nor its employees provide tax or legal advice. You should consult your accountant, tax adviser and/or attorney for advice concerning your particular circumstances. This information should not be construed as specific tax or investment advice. Please contact a tax advisor regarding the suitability of tax-exempt investments in your portfolio. If sold prior to maturity, municipal securities are subject to gains/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes based on the investor’s state of residence.
For more information on COVID-19, please refer to the Centers for Disease Control and Prevention at cdc.gov.
Neuberger Berman Investment Advisers LLC is a registered investment adviser. The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.