Seasonality has had a relatively consistent impact on municipal bond supply and demand conditions through the years. Mid-summer and the first month of the year tend to be lag times due to distinct issuance and maturities factors of the municipal bond market. This is when the benefits of having an active municipal bond manager may become even more pronounced.

Summer Slowdown for New Muni Supply
For the more than 50,000 municipal governments across the United States, their main focus tends not to be on the financial markets. Instead, their bond financing is looking to deliver specific services to communities – such as education, health care, transportation, and other essential services. Also, except for the largest muni bond issuers, many have small finance staffs.

Budget cycles for many states are on a July 1 fiscal year. Therefore, until budgets are established and financial projections are completed, many issuers are typically unable to provide the detailed financial statements necessary to prepare a new bond prospectus. Consequently, municipal bond issuance often declines in the summer months and then picks up again in autumn.

Time to Manage Maturities
Another factor influencing budget cycles is the timing of maturities, calls, and interest payments. In a typical year, maturities peak in January and July. The following chart shows net supply (Issuance – Maturities) for the past three years. As of June 30, 2018, the pronounced impact of the significant decrease in net supply is evident. Investors who own bonds maturing in July will be forced to compete for reinvestment. By some estimates, net supply this July could be around negative $110 billion. This means reinvestment may be considerably challenged given expectations of 2018’s low muni bond supply.

Municipal Bond Market: Net Supply

Four Ways to Actively Make a Difference
As we move into summer, consider the following ways an active municipal bond manager may help investors overcome seasonality issues.

  • Control reinvestment: One of the primary goals of active management in fixed income is to manage and control reinvestment. Over long periods of time, reinvestment can have the most significant impact on returns. To paraphrase a quote long attributed to Albert Einstein, “Compound interest is one of man’s greatest inventions.”
  • Avoid peak periods: Investors in passive strategies like bond ladders have no choice but to wait until a bond matures. But if their bonds mature in July, they will be forced to compete to reinvest during one of the most challenging periods of the calendar year. Active management works to control reinvestment by regularly and consistently adjusting duration to a strategy target. Also, they can avoid peak periods by selling bonds which mature at peak times months, or even years, before maturity.
  • Rebalance durations throughout the year: Consistent duration rebalancing at multiple times a year can more effectively manage reinvestment by avoiding troughs in issuance and seeking to capture peaks.
  • Target opportunity: Interest rate volatility during the year can provide even more opportunities to control and potentially enhance reinvestment.
Seasonality is one issue that active municipal bond managers can help alleviate this summer. However, their true benefits, I believe, are felt year in and year out.

 


This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.

Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation and liquidity. Municipal markets may be volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities.

Unlike passive investments, there are no indexes that an active investment attempts to track or replicate. Thus, the ability of an active investment to achieve its objectives will depend on the effectiveness of the investment manager.

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