The municipal bond market is nowhere near as bad as it was presented two years ago, but that doesn't mean it is free of risks and challenges for financial advisers building bond portfolios for clients.
“Investors know the market has changed,” said George Friedlander, managing director and chief municipal strategist with Citi Investment Research & Analysis. “And there's a real challenge for advisers working with individual investors.”
Indeed, Mr. Friedlander cautioned that the typical muni bond investor thinks that he or she has too much duration risk but, in fact, has too little.
UNNAMED SEER
Mr. Friedlander, speaking Monday in Chicago at the CFA Institute's annual conference, twice made allusions to Meredith Whitney's famous prediction of widespread muni bond defaults but jokingly refused to mention the eponymous advisory firm's chief executive by name.
Ms. Whitney, who wrote a prescient report on Citigroup that foreshadowed the financial crisis, predicted in 2010 that losses from muni bond defaults would cause “hundreds of billions of dollars” of losses.
“In order for her predictions to come true, all [of the largest municipalities] would have had to default,” he said. “Be that as it may, the predictions scared the bejeesus out of the muni market.”
Mr. Friedlander attributed the “sharp outflows” from muni bond funds over the past two years to predictions that the muni market was teetering on the brink of collapse.
And he acknowledged: “We do have more defaults to deal with, but not the kind of magnitude that scared people out of muni funds in 2010.”
STILL FRIGHTENED
That fear among individual investors is underscored by the $347 billion worth of redemptions last year, against $295 billion in new muni bond issuance.
Mr. Friedlander expects issuance to reach $350 billion this year.
He remains concerned, however, about the level of fear among individual investors.
“Individual investor demand has been just OK, because they are resistant to the lower rates,” Mr. Friendlander said. “Whenever there's a reduction in rates, individuals go into rate shock, and that is purely an individual investor mindset because institutional investors will consider whether rates are going up — not whether or not rates used to be higher.”
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