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 the lows (meaning the highs in rates) earlier this year because the risks seemed too great at the time.
Still, fund portfolio managers will welcome the shift: When cash was leaving it forced many managers to dump bonds at cheap prices.
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 made a now-infamous prediction 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 pros 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.
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 proved to be a bust, at least so far. 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. As the chart shows, the Bond Buyer index yield fell to 5.36% on Wednesday, the lowest since Dec. 6.
The flip side is that muni mutual fund investors have seen their share prices climb, in some cases non-stop since mid-April. The Vanguard California Long-Term Tax-Exempt fund’s share price rose 1 cent to $10.95 on Wednesday. The price has either risen or held steady every day since April 11, and is up 3.5% since then.
But muni experts warn that the rally has primarily been in the highest-quality bonds, leaving plenty of lower-quality issues behind.
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.
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 on Wednesday, she implied that investors were underestimating the severity of state and local governments’ funding shortfalls for employee pensions and health-care benefits.
Just as some municipal labor unions are being forced to renegotiate contracts with governments, “Municipal bond holders will experience their own form of contract renegotiation in the form of debt restructurings at the local level,” she wrote.
But this time, Whitney didn’t attach a dollar amount to her prediction.
-- Tom Petruno
Photo: Meredith Whitney. Credit: Jonathan Alcorn / Bloomberg News