"I don't think our investors recognized the potential volatility of long-term bonds." That's how Doug Byrne explains the flight of shareholders this year from his Emerald Fl. Tax Exempt bond find.
In a year of widespread shareholder defections from open-end muni funds of all stripes, Byrne holds the distinction of managing the most unloved fund, based on data compiled for The Bond Buyer by Morningstar Inc.
After adjusting for a negative 7.47% return in the first 10 months of 1994, the fund's asset size on Oct. 31 had plunged by 35% from the yearend 1993 level, reflecting a slew of redemptions by holders of the fund's A shares. Byrne just recently set up a separate class of B shares for the fund.
The Emerald fund's 35% decline in adjusted cash flow compares with an average decline of 6% for 253 open-end muni funds tracked by Morningstar for the purpose of constructing the ranking. Morningstar only looked at funds that had assets of at least $200 million at yearend 1993.
Even before the blowup in Orange County, a number of California muni funds were seeing significant redemptions. Of the 10 funds that suffered the biggest outflows of cash on a percentage basis through Oct. 31, three were California funds.
Jack Haley, who runs several California muni funds for Fidelity Investments, said Thursday that he had not seen an acceleration of redemptions in the wake of Orange County's bankruptcy filing last week, which was prompted by massive paper losses in the county's investment fund.
Two funds managed by Haley - Fidelity Spartan CA Muni High Yield and Fidelity CA Tax-Free Insured - were among the 10 biggest percentage losers, based on adjusted cash flow.
Those funds, as well as Fidelity Spartan Municipal Income - a national fund that was also among the top 10 losers - grew rapidly in 1992 and 1993, as yields were declining.
"As such, those funds have a higher percentage of investors who have a high-cost basis," Haley said. Once investors get close to, or below, their cost basis, "they leave."
Haley also acknowledged that he was a bit unprepared for the severity of this year's rout in the bond market. "We entered 1994 with a more constructive outlook on the market," he said. "Needless to say, we tempered that view during the year."
As for the Orange County mess, Haley said none of Fidelity's three California muni funds holds uninsured direct obligations of the county, though the funds have uninsured exposure to six municipalities that invested in the Orange County investment pool. The combined exposure of the three Fidelity funds is less than $25 million, he said.
Based on a preliminary review, none of the six municipalities invested debt-service reserve finds in the pool, Haley said.
"Therefore, all of the issues we hold have debt-service reserve funds which would provide a cushion for the issues" while the problems of the Orange County investment pool get sorted out, Haley said.
As a group, muni funds that ranked highest in the first 10 months of this year in terms of cash flow tended to do somewhat less badly on a performance basis than those that saw the biggest cash outflows.
Still, some of the poorest-performing funds were among the biggest gainers on a cash-flow basis.
Take Alliance Muni Income National B. The fund's return was off 10.42% in the first 10 months of the year, but adjusted cash flow of the fund's B shares rose 13%
"You can't say people went in because the fund did well," said Patricia Brady, a municipal analyst at Morningstar, adding, "I think the gain [in cash flow! might say something about the sales force [rather] than the fund itself."
Brady also pointed out that the fund's A shares lost a considerable amount of assets during the same period.
Susan Peabody, who runs the fund, is unapologetic about its performance this year, saying she has always been an aggressive manager, buying bonds when they're cheap, and maintaining a fully invested portfolio. "While the return goes down with the market, in the long run we feel shareholders are better off in terms of building a longterm track record."
Similarly, investors have continued to flock this year to Rochester Fund Municipals, a $1.85 billion New York State fund, despite its dismal performance in the first 10 months. Though it was off 8.04%, adjusted cash flow through Oct. 31 was up 11%, or $202 million, the biggest dollar gain of any of the funds.
Morningstar's Brady said the long-term term fund has had a good track record since its inception, and saw huge asset inflows in 1993. "I think the momentum just didn't stop," she said.
Ronald Fielding, president of Rochester Funds, attributed part of continued gains in cash flow to his efforts to keep investors plugged in.
"We have had a long-term policy of communicating in a substantive way our investment philosophies and strategies to shareholders and the brokers that sell the fund," he said.
Some of Fielding's investment strategies, though, could make conservative investors blanch. For example, he still has a number of inverse floaters and zeros in his portfolio.
"This is not your arden-variety muni fund - this is a wild and woolly one," said Brady.
Fielding also offered another reason why shareholders haven't decamped. "We're a load fund:" he said. "Because people paid an admission price, they're less likely to take their money out."
Conversely, Michael Brilley, the manager of Sit Tax-Free Income, a national fund that is part of the Sit Mutual Fund Group in Minnesota, said a 20% decline in adjusted cash flow through the first 10 months of this year stemmed partly from the fact that his fund has no load.
"No-loads tend to have more redemptions in a bear market than load funds," Brilley said.
Off just 1.1% as of Oct. 31, Brilley's Sit Tax-Free fund has weathered the bear market pretty well, so load or no load, the big cash drain appears unwarranted on the surface.
Brilley explained that many of the shareholders who dropped out of the national fund reinvested in a Minnesota fund that he started last November.
The new single-state fund has about $35 million in assets, and most of that came out of the national fund, he added.
Elbridge Gerry, portfolio manager of Pierpont Tax-Exempt, also attributed much of the decline in that fund's cash flow this year to the recent creation of a state fund for New York investors.
Launched in April, Gerry's New York fund has assets of over $40 million, and about half of that amount was siphoned from the national fund.
Established muni funds, meanwhile, increasingly have been issuing new classes of B shares to attract new investors.
"They've become very trendy recently," said Morningstar's Brady
Indeed, the top three percentage gainers in adjusted cash flow, as ranked by Morningstar, were not really funds as such, but the B class of the funds.
Typically, holders of the B shares pay a deferred load that decreases annually, and disappears if the shares are held for five years.
Joe Deane, who runs Smith Barney Shearson's Managed Municipals fund, said the creation of a B class is "one of the reasons why we've been getting cash." The B shares saw a whopping 64% increase in adjusted cash flow in the first 10 months.
Deane also adopted a very defensive position late last year, which served him well in his standing with shareholders when the bond market started to tank, in, 1994.
"We try to manage money based on where we think the market is going, and people responded to that," he said.
Larry McDermott, Deane's colleague at Smith Barney Shearson, didn't fare as well. His Tax-Exempt Income B was one of the top losers in terms of adjusted cash flow.
"Basically, Joe was performing much better" carrier in the year, McDermott said. "Obviously, [Smith Barney] is going to market the fund that has a better return," he added.
Right now, Deane said his Managed Municipals fund is pretty aggressively positioned, with an average maturity of about 22 1/2 years, compared with 14 years in late 1993 and early 1994.
In Florida, Doug Byrne said he is maintaining a more defensive position than managers of other Florida muni funds.
The average maturity of his Emerald fund is now about 19 1/2 years, though at one point this year, he said, the average maturity was 17 1/2 years.
After the stomach-churning drop in, bond prices this year, Byrne said he holds a "constructive" view about 1995. On the retail side, Florida investors-continue to snap up individual muni issues and Byrne said some of that demand probably will spill over, into-muni mutual funds.
Meanwhile, after getting hit with a deluge of redemptions this year Byrne said he is conducting seminars with his distributors, "trying to be pro-active with those that sell the fund"