Cash outflows from muni bond funds halt as market rallies
The bleeding finally has stopped: Municipal bond mutual funds took in a net $38 million in new cash from investors last week, the first inflow since November, new data show.
The turnaround for the muni fund industry follows six straight weeks of rising bond values and falling interest rates, as the $2.9-trillion tax-free muni market has rebounded after a wave of selling late last year and early this year.
The return to cash inflows suggests that many investors are buying only because the market is rallying; they passed up the chance to buy at higher yields earlier this year because the risks seemed too great at the time.
The muni sell-off from November to late January had been triggered by surging worries about the health of state and local government finances. It was egged on by Wall Street banking analyst Meredith Whitney, who in late December predicted that “hundreds of billions of dollars” of municipal bond debt would end up in default in 2011.
Whitney was roundly trashed by many muni market professionals for fueling a panic in the market. As bond values fell, driving down the share prices of muni mutual funds, investors fled the funds in droves — causing further declines in muni values and driving yields sharply higher.
The annualized tax-free yield on the Bond Buyer newspaper’s index of 40 long-term muni bonds nationwide soared to a two-year high of 5.95% in January.
Muni funds had net outflows of $7.7 billion in November, $12.9 billion in December and $12.4 billion in January, according to the Investment Company Institute. Those were significant sums given that the funds held about $470 billion in total at the end of December.
The outflows have slowly tailed off since January as Whitney’s prediction has proved, at least so far, to be a bust. Muni defaults this year have been normal or below normal — totaling in the hundreds of millions of dollars, not billions.
As money has moved back into munis, yields have tumbled. The Bond Buyer index’s average yield fell to 5.36% on Wednesday, the lowest since Dec. 6.
As yields have dropped, muni mutual fund investors have seen their share prices climb, in some cases nonstop since mid-April. For example, the Vanguard California Long-Term Tax-Exempt fund’s share price is up 3.5% since April 11.
But the rally has primarily been in the highest-quality bonds, leaving plenty of lower-quality issues behind, muni experts say.
What’s more, the dearth of new bonds this year, as state and local governments have cut back on debt issuance, has meant that investors’ appetites for munis haven’t been tested meaningfully.
“There is no supply pressure,” said Matt Fabian, senior analyst at research firm Municipal Market Advisors in Concord, Mass.
“Selling has been down and trading volume has been down too.”
The thin market has made it easier for bond prices to move higher and yields lower. Munis also have benefited as many investors have favored bonds, in general, over stocks in recent weeks because of concerns about slowing U.S. economic growth.
For her part, Whitney refuses to back off from her warning of worse to come in the muni market, despite the recent rally. In a Wall Street Journal op-ed piece Wednesday, she implied that investors were underestimating the severity of state and local governments’ funding shortfalls for employee pensions and healthcare benefits.
Whitney warned of “debt restructurings at the local level,” but this time she didn’t attach a dollar amount to her prediction.
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