The Illinois Budget and Muni Opportunities to Watch in Q4
This transcript was edited for clarity
TOM BUTCHER: Jim, thanks very much indeed for joining me today. Illinois has reached a budget accord. What’s this going to mean for munis?
JIM COLBY: Well, it’s a remarkable event, Tom, because, for the better part of two years, the Illinois legislature and its governor just could not, and would not, come to an accord to formalize or finalize a budget. And during that period of time the outstanding debt which is substantial in the municipal marketplace, Illinois being one of the top five issuers of bonds in the United States. They saw the valuation and credit rating of those bonds drop precipitously. And I think the rating agencies did the right thing, they said: “Look, there’s no accord. There’s no assurance that the bonds are going to get paid, or that money will be provided for ongoing operations.” And in a state like Illinois, which has great resources, and a city like Chicago, that has great resources, fell to the lowest levels of the investment grade spectrum and into what we call high yield, below investment grade. Astounding series of events. Still, it provided great liquidity to the high yield marketplace. And in an odd situation, because valuation, it provided a boost to yields. And, ultimately, when the accord finally occurred a month ago, there was a great rebound in valuation. And some assurance from the credit rating agencies that, okay, no more downgrades to come and it looks like, temporarily anyway, the budget issues are being resolved. And at the end of August, looking back at the previous six months, Illinois was one of the top performers among the States as spreads narrowed from their incredibly wide valuations of two or three months ago, they narrowed substantially to provide a great boost to high yield and investment grade portfolios.
So we’re back on watch because they haven’t solved all the problems legislatively. It looks like Illinois is going to issue nearly $6 billion worth of new bonds to help bridge some of the near term gaps and cash needs, pay off their vendors, and provide distributions to the university system in the state as well as support Chicago and the Board of Ed. So Illinois has been just a remarkable story, and providing all kinds of interesting sidebars. But ultimately having a significant impact on investment grade as well as high yield bonds across the spectrum.
BUTCHER: Thanks very much. And it sounds as if there are probably some opportunities in the last quarter of the year. Could you tell me a bit about them?
COLBY: Well, Tom, I do think that with what’s occurred over these past eight or nine months, and particularly with equities doing so well, there’s been a bit of overshadowing of interest for tax exempt investors. And I’m glad we’re doing this today because opportunities are still significant in the municipal marketplace. What do I mean by that? Well, we have, by our traditional measures at VanEck, we see that valuations of investment grade, low investment grade bonds to highest quality investment grade bonds; that spread relationship is still above the long-term average. The valuation of municipal high yield to corporate high yield, which is another traditional measure; that spread relationship is still above the long-term mean relationship of those two. So those two signals alone are suggesting that there’s value in the marketplace, both for investment grade as well as high yield. And I would just like to point out, Tom, too, in a couple of instances that are under the radar perhaps, munis have flown. But those people who have not focused on fixed income and tax exempt investing will be surprised when they look at the year-to-date numbers in high yield as of September 30, the Bloomberg Barclays Municipal Custom High Yield Composite Index has returned over a taxable equivalent of 14.85%.*
And for our intermediate investors, those who don’t want to take either the credit risk of high yield or the long-term risk of the 30-year marketplace, our Intermediate Index (The Bloomberg Barclays Capital AMT-Free Intermediate Continuous Municipal Index) has returned over 6% tax free. And that’s over 9% taxable equivalent*. So those numbers alone, Tom, suggest that opportunities still reside in the municipal marketplace. And notwithstanding the great returns that have occurred in some elements and aspects of the equity marketplace, munis are still an important asset class and they should not be forgotten in terms of the asset allocation models that individuals and their advisors apply.
BUTCHER: And the big question is how should investors actually access these opportunities that you’ve just set out to me?
COLBY: Well, the creation of Exchange Traded Funds [ETFs] is precisely built, if not expressly, for those individual investors, for those investment advisors who don’t know all the intricacies of the municipal marketplace. But the ETFs with their broad diversification, their transparency, and access to the tax exempt income on a monthly basis, using the equity market, using the different equity exchanges, compensate individuals for their lack of expertise. They’re putting the responsibility back on our shoulders and the structure of the ETF. And that structure has continued to prove out the value and worth to the investing population.
BUTCHER: Jim, thank you very much indeed.
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*Based on the highest U.S. Federal tax bracket of 39.6%. For investors in other tax brackets, results would have been lower. Bloomberg Barclays Municipal Custom High Yield Composite Index (LMEHTR), which is intended to track the overall performance of the U.S. dollar denominated high yield long-term tax-exempt bond market. The Bloomberg Barclays Capital AMT-Free Intermediate Continuous Municipal Index is a market value weighted index designed to replicate the price movements of medium-duration bonds.
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