PASADENA, Calif., Nov. 20, 2014 /PRNewswire/ -- Over the past year, municipal bond markets have experienced resurgences that have made them increasingly attractive to a broad range of investors. Yet, municipal fixed-income bonds can be complex, and analyzing and finding value among the many securities available can challenge even for experienced financial managers.
Western Asset Management (http://www.westernasset.com), a subsidiary of Legg Mason, considers municipal bonds appealing for many reasons. They are owned not only by the affluent but by many investors with moderate incomes. This reflects their security, attractive total return possibilities and tax benefits. They are essential cornerstones to investors seeking diversified portfolios, especially in volatile markets.
To Robert Amodeo, a portfolio manager with Western Asset, this means investors should be open-minded yet vigilant.
"There still is good value to be found in municipal bonds," he explained. "Weak performance in 2013 improved the municipal market's relative attractiveness, particularly versus taxable securities, but the rally over the last 10 months has resulted in a more fully-valued market."
Western Asset sees several key themes in today's municipal market that investors should watch:
- The sector posted solid gains during the most recent quarter and outperformed the broad taxable market.
- Lower yields, a flatter slope of the yield curve and tighter credit spreads warrant a guarded outlook, but Western Asset believes attractive opportunities exist in many municipal sectors.
- Western Asset certainly expects municipals to outperform U.S. Treasuries into 2015 and to post competitive returns versus taxable sectors.
- However, Mr. Amodeo counseled, "This has become a marketplace that requires professional credit expertise and surveillance."
Resilient as municipals are, these markets have confronted their share of broad challenges. These include secondary effects from the partial shutdown of the U.S. government and the U.S. Treasury debt ceiling debates between the White House Administration and Congress, as well as extraordinary fiscal and monetary policies. Severe credit problems in Detroit and Puerto Rico have been well documented. Broader negative demand cycles and spiked volatility driven by negative news headlines have contributed to the challenge.
While no longer the biggest story in the sector, Detroit has had a significant impact.
"The default of Detroit illustrated all too well that municipal credits can be complex," Mr. Amodeo said. "We pay close attention to the legals and the covenants in every bond we buy, and exercise care in assessing the level of risk we take on."
The Western Asset team's in-depth analysis shows that balance sheet strength is uneven among states and other municipalities.
"State balance sheets have generally improved along with the economy, although the trend is less positive at the local level," Mr. Amodeo said. "Fiscal discipline continues to vary from region to region. Financial flexibility remains low for many states and localities. There is little cushion between spending plans and tax receipts, so future shortfalls in revenue could create budgetary challenges."
Thus, Western Asset considers revenue bonds more attractive than general obligation bonds.
"Our bias is for Single-A rated revenue bonds over G.O. bonds," Mr. Amodeo advised. "We expect greater stability in the ratings of well-chosen essential service revenue bonds, with the potential for upgrades where balance sheet fundamentals improve. The most attractive revenue bonds include those backed by utilities, health care/hospitals, industrial development revenue (IDR), pollution control revenue (PCR) and education services.
Within G.O. bonds, states are better positioned than local counterparts, many of which continue to experience lackluster property tax receipts."
Many of these disparities are driven by demographic shifts. The Western Asset team considers mobility of the labor pool a key factor in municipal bond decision-making. State and local economies offering healthy activity will attract the best companies and their employees.
"Economic power in the U.S. is shifting," Mr. Amodeo explained. "Interstate competition for jobs and growth are largely being won by southern states such as the Carolinas, Florida, Texas and Tennessee. Some states out west also are doing better, such as Arizona, as well as the Dakotas with their oil boom. Utah and Wyoming are doing well too."
"Investors will be well served by watching for signs of potential economic decline in regions. Population loss, stagnant or falling home values, reduced tax bases leading to low financial flexibility, and business out-migrations are just some of the key factors we watch closely. It should be no surprise that many northeast states with high living costs lost population during the past decade."
While positive in its outlook for the overall municipal market, Western Asset remains attentive to issues that could negatively impact investor sentiment: concerns over potential rate hikes by the U.S. Federal Reserve, spillover effects of weak growth and deflationary pressures in Europe and Asia, geopolitical issues, and fallout from the November midterm elections.
While not new, pension funding woes promise to make front-page news on an irregular basis.
"We are thoroughly engaged in understanding pension liabilities and the degree to which each state and large city projects pension benefits, all of which have significant importance for bondholders," Mr. Amodeo said. "We will continue to monitor developments in Puerto Rico, New Jersey and especially Illinois, all of which face challenging fiscal conditions."
Mr. Amodeo believes Illinois and New Jersey present tough challenges to policymakers and the markets.
"Their fiscal condition is better than a few years ago, but less of each budget goes to pay for current services. More must pay for obligations, deferrals, under-appropriations and short-term fixes of the past. Their financial management has been weak at best. Can these states meet their obligations? At this stage we believe so, but we will be watching closely for signs of further weakness."
About Robert E. Amodeo, CFA
A portfolio manager with 26 years of experience in fixed-income markets, Robert Amodeo has been with Western Asset Management since 2005. Previously he worked for Salomon Bros. Asset Management from 1992 to 2005, rising from analyst to managing director; Salomon Brothers Inc., from 1988 to 1992, as an analyst after starting as an accountant; and as an accountant from 1987 to 1988 at The Bank of New York. Mr. Amodeo earned a Master of Public Administration in advanced management and finance from Columbia University, and a B.S. from Long Island University. He is a Chartered Financial Analyst.
About Western Asset Management
Western Asset Management is one of the world's leading fixed-income managers with $472 billion in assets under management as of September 30, 2014. The firm is a wholly owned, independently operated subsidiary of Legg Mason, Inc. ( NYSE: LM) From offices in Pasadena, Hong Kong, London, Melbourne, New York, Sao Paulo, Singapore, Tokyo and Dubai, the company provides investment services for a wide variety of global clients, across an equally wide variety of mandates.
About Legg Mason
Legg Mason is a global asset management firm, with $720 billion in AUM as of October 31, 2014. The Company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).
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