Challenges in Today’s Municipal Market

Most fixed-income investments carry two key risks: interest-rate risk and credit risk. Both affect a bond’s value in the market. But before the 2008 financial crisis, interest-rate risk was the primary concern of many investors and investment managers—credit risk was much less of a consideration. My colleague Michael Brooks explains why.

The reason is that approximately 70% of municipal bonds prior to 2008 were rated AAA. Some of these bonds were legitimately of the highest quality, but with others, bond insurers appeared to eliminate one of the risk variables with a nice trick: they would guarantee lower-rated bonds and give them a AAA rating.

It worked—until the insurers themselves lost their AAA ratings, and the bond-insurance industry subsequently collapsed.

Prior to 2008, insured bonds represented more than 50% of issuance; today, they represent less than 4%. Investors can no longer rely on the crutch of bond insurance. All bonds today require in-depth credit analysis. And the truth is, they always did. We always looked to the underlying credit quality of a bond to make investment decisions.

The upside is that today there are far more lower-rated bonds available, and such bonds offer a substantial yield advantage. At the start of 2007, A-rated and BBB-rated securities comprised only 14% of the market; such bonds now represent more than 30% of the market, according to Barclays Capital. However, earning that extra yield requires significant fundamental research into the minutiae of an issuer’s financial management. Before purchasing a bond, it’s imperative to understand what short-term or long-term problems an issuer may face, and how they are being resolved.

Additionally, for an investment manager doing any kind of tactical overlay—especially managing for taxes—it’s crucial to capitalize on short windows of investment opportunity. But you can’t be nimble without the ability to very quickly do in-depth research on the bonds you’re interested in. There are too many pitfalls.

And today there’s another hurdle: increased regulation. As an offshoot of the Dodd-Frank Act, the SEC and FINRA have issued new rules on disclosures financial advisors must make when selling individual bonds to investors.  

Because of the need for in-depth research, an actively managed municipal bond mutual fund may provide some investors with a more effective and flexible approach than a portfolio of individual bonds would. Investors in such actively managed funds gain the advantage of a full-time professional manager, one equipped to decode the risk and return potential behind the staggering array of variables that characterize the bond market. Financial advisors benefit, too—they’re freed from the need to conduct due diligence when selecting the appropriate bonds, so they can dedicate more time to servicing their clients.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio- management teams.

Douglas J. Peebles

Chief Investment Officer—Fixed Income
Douglas J. Peebles is Chief Investment Officer, a Partner of the firm, and Head of Fixed Income, focusing on AB’s fixed-income investment processes, strategy and performance across portfolios globally. As CIO, he is also Co-Chairman of the Interest Rates and Currencies Research Review team, which is responsible for setting interest-rate and currency policy for all fixed-income portfolios. In addition, Peebles serves as Lead Portfolio Manager for AB’s Unconstrained Bond Strategy, and focuses on managing the firm’s strategic client relationships. In 1997, he pioneered AB’s highly successful and innovative approach to global multi-sector high-income investing, which is now being adopted by other firms. Since joining the firm in 1987, Peebles has held several leadership positions, including director of Global Fixed Income (1997¬–2004), co-head of Fixed Income (2004–2008), and his current position (Head of Fixed Income), which he assumed in 2008. He holds a BA from Muhlenberg College and an MBA from Rutgers University. Location: New York

Michael G. Brooks

Senior Portfolio Manager
Michael G. Brooks joined Bernstein in 1991 as a senior municipal credit analyst and is a member of the Tax-Exempt Fixed-Income Investment Policy Group. For the preceding 13 years, he was with the Office of the New York State Comptroller, most recently as director of its Bureau of Fiscal and Economic Analysis, where he was responsible for monitoring the finances of New York City and forecasting its tax revenues and economy. Prior to that position, Brooks was a planning consultant, forecasting the impact of locating nuclear power plant facilities in Maryland. He frequently makes presentations to groups of clients and investment professionals on a variety of subjects relating to municipal bonds. Brooks earned a BA in urban economics from The City College of New York and an MA in city and regional planning from Rutgers University. Location: New York

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