Computer-generated reports exaggerated the amount of redemptions in October by investors in municipal bond funds, according to a Smith Barney Inc. portfolio manager.
"We've gotten virtually no redemptions," said Joseph P. Deane, managing director of tax-exempt fixed-income management at Smith Barney's Greenwich Street Advisors.
What's more, Deane said he has spoken with portfolio managers at other mutual fund companies who also claim redemptions in October were minimal.
This is despite the fact that municipal dealers have recently reported seeing lists of bonds for sale from mutual funds averaging between $300 million to $500 million daily.
So why doesn't Deane believe the huge redemption figures reported by AMG Data Services and other firms that track the flow of funds?
Deane, a self-described "amateur contrarian," attributes the rise in fund outflows last month to moves by fund managers to deleverage their portfolios by linking derivatives.
To deleverage, a portfolio manager who owns the leveraged, fixed-rate portion of an inverse floater exercises his option to buy the floating-rate portion of the security. The linked security then resembles a normal, fixed-rate bond.
Deane estimated that approximately one-third to one half of all reported redemptions in October were due to portfolio manager sales in order to deleverage.
In the week ended Oct. 26, AMG figures showed more than $930 million flowing out of the more than 1,600 long-term municipal bond funds it tracks.
"It was a computer reading the deleveraging," Deane said.
But Bob Adler, president of AMG Data, said the number he uses to show movements of cash in and out of mutual funds by investors doesn't include portfolio manager selling.
"The numbers don't lie," Adler said. "The calculation measures the net of purchases and redemptions and assumes all distributions are reinvested. Because it assumes reinvestment of distributions, net redemptions are actually overstated."
Portfolio managers' buying and selling affects the market value of a fund, another figure that AMG tracks, Adler said.
Some other portfolio managers also differed with Deane's contention that the October redemption figures were overstated.
"When I reconstituted inverse floaters in February, I sold long duration bonds to purchase the floating-rate portion of inverse floaters. For our funds, the net effect on market value was zero," said Patricia M. Dolan, a managing director and portfolio manager for Prudential Investment Advisors.
In other words, the transactions canceled each other out.
Despite the skepticism regarding his theory about what's behind the reported spike in redemptions, Deane is sticking to it.
"I'm just trying to come up with a rational thought process as to why the numbers would be so much higher in October without people saying they're getting redemptions," Deane said. "Maybe I'm wrong, but I doubt it."
Meanwhile, Deane has been repositioning his portfolio in recent weeks to reflect his bullish market outlook. Anticipating that interest rates are peaking, Deane said he has been buying discount bonds, in part to build up call protection for his portfolio.
The Smith Barney portfolio manager also has lengthened the duration of his portfolio and is not employing the municipal futures contract to hedge. Deane said he also has a low cash position.
Employing his contrarian strategy, Deane correctly called the bottom of the bond market in October 1993 and turned bearish, repositioning his portfolio to reflect anticipated rising interest rates before most other market participants did.
At an investment outlook roundtable held by Smith Barney on Wednesday, Deane said he has been "buying into the bottom of the market" for the past two weeks, lOoking for double-A and triple-A paper.
Deane admitted that he was surprised by the steep drop that the municipal market has suffered in recent days, but he appears undeterred.
"When the snap comes, we want to be loaded," he said.
