and Core Muni Funds
Sponsored Content – American Century Investments
By G. David MacEwen,American Century Investments,
Chief Investment Officer, Fixed Income
January 24, 2012
Positive municipal bond (muni) performance in 2011 was a surprise to many after the angst at the end of 2010. While a relative performance encore of last year’s magnitude might be difficult to muster, we believe muni market fundamentals remain resilient, which is the cornerstone of our case for munis and muni funds in 2012 and beyond.
2011 was a remarkable year for the muni market, after the turmoil that occurred at the end of 2010 and spilled into the beginning of last year. Highly publicized projections of hundreds of billions of dollars in defaults in the coming year roiled the market, triggering a wave of redemptions from muni mutual funds.
Value Opportunities, Declining Defaults
As we observed then, those were classic, contrarian conditions, opening market entry points for long-term investors. We believed the highly publicized, pumped-up default estimates over-emphasized projected municipal liabilities and underestimated muni issuer flexibility, especially for raising revenues and cutting expenses. We still see municipal credit quality as “challenged, but resilient,” in this slow-growth/recovering economy. Muni defaults remained relatively rare in 2011, consistent with their historic pattern, and mostly non-systemic in our view, triggered primarily by specific structural failures and/or poor planning, undermined by the weak economy. Defaults actually declined in 2011 compared with 2010, while tax revenues increased marginally and municipal spending was cut. We expect muni defaults to remain relatively isolated events in 2012 and beyond.
Meanwhile, negative headlines subjected munis across the credit-quality spectrum to similar downward price pressures, opening value opportunities for investors seeking fundamentally sound bonds at low prices. One key muni relative-value metric—the ratios of AAA muni yields to U.S. Treasury yields of the same maturity— exceeded 100% for much of 2011 (vs. historic averages of closer to 95%). These values attracted institutional buyers at the same time traditional retail investors were bailing out. In alignment with last year’s Treasury rally, munis generally posted solid performance in 2011, better than the U.S. bond market average. As Treasury yields fell, muni/Treasury yield ratios soared well above 100%, which appeared likely to hold into the new year.
Muni Opportunities Ahead; Fund Resources to Tap
Besides the recent tactical value opportunities, munis continue to offer fundamental strategic attributes with evergreen appeal to investors and advisors, including:
- Competitive yields, particularly on an after-tax basis for taxable investors in high tax brackets.
- Generally high credit quality, relative to other bond sectors. We believe muni credit quality is second only to U.S. Treasury quality in the investment grade universe.
- Diversification and risk-adjusted return attributes. Investment-grade muni performance tends to be correlated with that of U.S. Treasuries (which serves as a useful diversifier from stock performance) but not 100% correlated. Munis’ reaction to changing economic conditions typically lags that of Treasuries, with less severity. This relative moderation can produce favorable risk-adjusted returns for munis compared with other bond sectors.
We like munis because of these opportunities and attributes. To fully capture their benefits, we typically suggest established core, diversified muni mutual funds with long performance records, instead of individual securities. Besides professional portfolio management and diversification potential, muni mutual funds can also provide professional credit analysis as a key part of their portfolio management expertise. We believe sound, experienced credit analysis is more important than ever in this challenging economic and market environment.
Generally, as interest rates rise, bond values will decline. The opposite is true when interest rates decline.
Diversification does not assure a profit nor does it protect against loss of principal.
American Century Investment Services, Inc., Distributor
©2012 American Century Proprietary Holdings, Inc. All rights reserved.
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