The Real ESG, Ep #22

I received my first securities license 30 years ago. Over these years, I’ve been exposed to many investment options. I’ve never been drawn to taxable bonds as an investment option. In my opinion, they’ve never been a good hedge against inflation and just don’t make sense. You’re giving the government money without any idea what it will be used for and expecting them to pay you back.But there is a sector of the bond market that has made sense to me for certain clients—the municipal bond market. Municipal bonds are issued by the state or local governments to build new roads, hospitals, schools, etc. You know exactly what the money will be used for. You also usually know how the money will get paid back. The interest from these bonds is exempt from Federal income tax—and depending on the state—state income tax. Today’s guest, Jonathan Mondillo, is an expert in the municipal bond market. He’s the head of the North American Fixed Income Division at Abrdn Asset Management. He’s also responsible for the firm's municipal bond franchise and the Abrdn family of Municipal Bond Mutual Funds. We dive into a conversation about municipal bonds in this episode of Upthinking Finance! You will want to hear this episode if you are interested in...[3:46] What drew Jonathan to the municipal bond sector[5:17] The difference between treasury and municipal markets [7:17] What does limited liquidity with bonds mean?[9:18] What Jonathan looks for with individual securities [14:22] Should insurance be a significant consideration? [17:08] A conversation about municipality bankruptcies[18:54] Navigating managed portfolios through the Great Recession[23:40] Two things advisors look at in the treasury markets[27:40] How politics influence municipal bonds [29:20] The impact of choosing municipal bonds [34:00] Are municipal bonds a separate asset class?The difference between treasury and municipal marketsThe municipal market is always compared to the treasury market. It introduces a bit more credit risk relative to treasuries. There tends to be some liquidity (which you are compensated for) and they are typically tax-exempt securities. The coupon you receive in treasury markets is taxable at the Federal tax rate. Investors choose municipal securities over treasury securities for several reasons, such as additional yield and credit exposure. What does limited liquidity mean?Over 50% of the marketplace is retail holders. They follow buy-and-hold strategies. When the market is going haywire and you need liquidity, it impacts your ability to sell the security. You have to wait for a retail holder to want to buy the security. But the treasury market is full of global buyers—institutional, retail, and government. One of the benefits of municipals is that they’re less volatile than the treasury market. We’ve seen that as international buyers have stepped away from the treasury market. What Jonathan looks for when choosing individual securitiesThere are distinct differences between municipal securities. A municipal bond is either a general obligation bond of a local municipality or a revenue-backed bond. If you’re looking at a general obligation bond, you start with both qualitative and quantitative factors. At a high level, you want to look at the governing structure, how consistent they are at passing budgets on time, budget performance, and socioeconomic factors of the municipality (wealth, unemployment rates, and where the revenue mix comes from). There’s a host of qualitative factors.When you shift to quantitative metrics, it has to do with budgets:What budgetary surplus have they run historically relative to the total budget? What does their balance sheet look like?What does the general fund balance look like relative to the overall budget?When you look at balance sheet metrics, they’ve become highly important compared to income analysis. Two things advisors look at in the treasury markets Advisors look at inflows and outflows. When they see treasury rates selling off and moving up, they tend to see outflows in municipal asset classes. Secondly, you can compare the yield on a municipal security relative to treasuries. Historically, anything inside of 20 years trades around 75% of a treasury yield. Municipal bonds may soften over the next couple of months as they catch up to the treasury market. They spend more time looking at the yield of a municipal security relative to a corporate security, especially going into 2023. Jonathan notes that we’ll see earnings compression, upticks in defaults, and an economic slowdown. When you look at ratios of municipal debt versus corporate debt, there is a historical mean that they look for around 70%. Things are landing in that sweet spot right now. Listen to the whole episode to learn more about the ins and outs of municipal bonds!Jonathan Mondillo is not affiliated with or endorsed by LPL Financial or Capital Investment Advisers.Securities and Advisory services offered through LPL Financial. A registered investment advisor. Member FINRA & SIPC.The financial professionals associated with LPL Financial may discuss and/or transact business only with residents of the states in which they are properly registered or licensed. No offers may be made or accepted from any resident of any other state. Connect With Jonathan MondilloConnect on LinkedInConnect with Emerson FerschCapital Investment AdvisersOn LinkedInSubscribe to Upthinking FinanceAudio Production and Show Notes by - PODCAST FAST TRACK