These are days of drama in the municipal bond market. And mutual fund manager Warren Pierson has a front-row seat.
From his offices in Milwaukee, the head of Baird Inc.'s Intermediate Municipal Bond Fund has watched at close range as investors and financial advisers alike have scurried to make sense out of their holdings. Pierson and his team manage a fund of some $900 million in municipal bonds and lately, he has also become part-time counselor and hand-holder.
"We've been getting more calls from the general public or affiliated financial advisers that have been using our fund," Pierson told Dow Jones Newswires. The most prominent reason, he said, is "they don't understand the bonds they own."
The calls aren't confined to the unsophisticated: Recently, the trust department of a nearby bank asked Pierson to vet a portfolio of bonds. They reveal how many investors and their advisers have, for years, ploughed money into municipal bonds without fully understanding them.
For decades, munis offered investors safe and steady investments that, on most days, basically functioned like ultra-safe Treasury bills. Few advisers or investors really spent much time researching their choices.
Since the financial crisis and economic recession, the market for municipal debt has gone somewhat haywire because of a confusing mix of falling government tax revenue, new laws in Washington and a rise in interest rates. That has some investors selling with the same lack of selectivity they demonstrated when they were buying.
The ranks of Pierson's nervous callers stretch well beyond mom-and-pop investors, to advisers who constructed "bond ladders" for clients. These have long been a favorite tool for conservative investors, like retirees, who used them to preserve their principal investment while taking in income.
But there's a catch: Advisers typically construct these ladders with specific bonds — typically as few as 10 or as many as 50. As a result, those portfolios can face jarring declines when just one or two bonds fall sharply in value.
Mutual funds, by contrast, hold dozens or hundreds of bonds. "I know it's self-serving to say this, but we really feel most people are best served by being in a fund," Pierson said.
Many advisers and investors have stumbled badly from what M. Sharon deGuzman, who helps manage the Baird fund, terms "call bonds," or bonds where the issuer, or debtor, has the option of redeeming the bonds early — often after the first 10 years of a 30-year bond.
For years, municipal bond issuers like city governments routinely redeemed their debt early to lock in new lower rates. But as interest rates rose recently, many of them have decided not to redeem. That lack of redemptions, combined with rising interest rates (which reduce the value of fixed-rate bonds), hammered callable bonds and jarred unsuspecting advisers and their clients.
Meanwhile, there have been dire predictions of widespread municipal default, but analysis by Pierson and his team contradicts that. For many municipalities, bond interest payments equal less than 10% of their annual budgets, deGuzman said, so they still have the flexibility to improve their finances.
There are important distinctions even among issuers who seem to be in the same tough straits and whom investors tend to group together. While many investors ran from bonds tied to Illinois and California, "we kind of stepped back and said, 'Wait a minute, they're not the same.' " He said Illinois, unlike California, had more room to raise income taxes. "Guess what? That's exactly what they [Illinois] did," Pierson said.
