Quarterly Update

William D. Black, Managing Director, Senior Portfolio Manager | Oct. 2020

High Yield Municipal Bonds Recover From Lows

High yield municipal market technical underpinnings are normalizing

The relative value of high yield municipal bonds offers opportunities

Rigorous credit research analysis will reward active managers

The high yield municipal bond (HYM) market has experienced an extraordinary ride in 2020. What began as a promising year for performance and investor sentiment abruptly shifted as the pandemic's unprecedented nature and economic dislocation unraveled markets during March. Fund flows turned decisively negative, while investors' inability to quantify the impact on fundamentals led to deterioration in liquidity and price discovery. The collective response of the Fed and Congress supporting economic recovery and financial market stability lured investors back, albeit slowly.

HYM performance recovered nicely from its March lows, with the Bloomberg Barclays High Yield Muni Index earning 4.55% and 3.09% on a linked quarter basis during 2Q20 and 3Q20, helping tip year-to-date return into positive territory. Credit spreads tightened considerably, with additional room for improvement should investor demand for income remain healthy. Metrics suggest HYM represents fair value versus investment grade municipals and is slightly cheap, on a tax-adjusted basis, against high yield corporates. A relatively well-balanced supply-demand dynamic offers the opportunity to price issues more on their intrinsic value. However, while gauges of volatility are currently at pre-pandemic levels, seasonal municipal market weakness and geopolitical factors, such as the presidential election and its potential impact on policy decision-making, could cause price fluctuations over the near term, likely creating attractive entry points.

The current credit backdrop places a high value on prudent underwriting standards, with a discerning eye on careful security selection. The economy has rebounded more quickly than previous estimates suggested, with the CARES Act and the gradual resumption of activity across states and regions lifting prospects for recovery. The negative impact on revenue sources securing HYM bonds is diminishing, and more resilient sectors, like select toll operators and suburban residential developments, should endure. Some parts of the market, such as senior living, are experiencing an uptick in default and impairment activity. While stress is likely to continue, it is unlikely to pose a systemic threat to the broader market. Disciplined credit research and opportunistic risk-taking should lead to favorable outcomes in the current environment for actively managed portfolios.

Key Points

High yield municipal market technical underpinnings are normalizing

The relative value of high yield municipal bonds offers opportunities

Rigorous credit research analysis will reward active managers

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Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.

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There are inherent risks with fixed-income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed-income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.

Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.

Alternative investments are speculative, entail substantial risks, offer limited or no liquidity and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying, and lengthy lockup provisions.

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Index Definitions

The S&P 500 Growth Index measure growth stocks using three factors: sales growth, the ratio of earnings change to price, and momentum.

The Dow Jones U.S. High Dividend Yield Index serves as a benchmark for income seeking equity investors. The index is designed to measure the performance of 80 high yield companies within the S&P 500 and is equally weighted to best represent the performance of this group, regardless of constituent size.

Bloomberg Barclays Municipal Bond Index is a market-value-weighted index for the long-term tax-exempt bond market. To be included in the index, bonds must have a minimum credit rating of Baa. They must have an outstanding par value of at least $7 million and be issued as part of a transaction of at least $75 million. The bonds must be fixed rate, have a dated-date after December 31, 1990, and must be at least 1 year from their maturity date.

The Bloomberg Barclays Global High Yield Index is a multi-currency flagship measure of the global high yield debt market.

Indices are unmanaged and one cannot invest directly in an index.

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