The recent wave of fear surrounding the municipal bond markets is overhyped, but the increased focus on the fiscal condition of state and local budgets is a good thing, according to Leslie Barbi, head of fixed income at RS Investments.
“It's true that state budgets are under a lot of stress right now, but we don't think there's going to be a big wave of defaults,” said Ms. Barbi, who heads a group managing $26 billion in fixed-income assets, including $3 billion at RS Investments, including the RS Strategic Income Fund Ticker:(RSIAX).
She described the increased attention on potential muni bond defaults as “headline risk” that is leading to increased volatility across the universe of about a million different muni bonds from 60,000 state and local issuers.
“It doesn't mean you shouldn't be nervous when a state has a big deficit, but not paying their debt service on bonds will not be their first option,” Ms. Barbi said.
In addition to a mandated high priority to pay the interest on municipal debt, states have lots of options at their disposal.
“I don't think you'll see big issuers defaulting anytime soon,” she said. “States have the ability to put the squeeze on the guys down the line, including counties and local municipalities.”
But while Ms. Barbi believes that the “worries about actual defaults are overblown,” she said the generally heightened level concern is good for everyone because it helps bring the issue front and center.
“The worry is what will help people to straighten out the budgets,” she said.
Of course, worrying alone can be a futile exercise if it does not lead to action.
Ms. Barbi cited the extreme belt-tightening in corporate America over the past few years as proof that budgets can be balanced and surpluses can be created.
“All the publicity of the high levels of budget stress is a good thing, although it does contribute to some headline risk,” she said, and added that the challenge will be to get politicians to start thinking and acting like corporate executives.
“Unfortunately, elected officials like to hand out the goodies, but they don't want to take the goodies away,” she said.
In terms of investing in muni bonds in the current environment, Ms. Barbi said investors should try to avoid the common mistake of focusing only on the tax advantages of bonds issued by municipalities in which the investor resides.
“Between one-third and half of all muni bonds are bought directly by retail investors,” she said. “And a lot of those investors only understand that if they live in New York, they should buy New York bonds for the triple tax exemption” of federal, state and local taxes.
But particularly in the current environment, where there are potentially hidden pockets of local muni market risks, investors should pay closer attention to the quality of the bonds in relation to the issuing municipality.
Sometimes, she said, it can be worth it to forgo a local tax exemption for a better muni bond investment.
All muni bonds, regardless of the issuer, are exempt from federal taxes. But state and local exemptions are available only for residents of those jurisdictions.
Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.
