Municipal HY Attractive Relative to Corporate HY
Given the steady and significant compression of corporate high yield (HY) spreads/yields, I am showing the illustration below depicting the ratio, or yield, of the Barclay’s Municipal HY Index relative to the Barclay’s Corporate HY Index. As you can see, the ratio is now over +124%. A ratio above 100% indicates that tax-free bonds are yielding more on an absolute basis than taxable bonds. By this measure, municipal HY is almost three standard deviations cheap to the average. When one considers the dramatically lower default experience of municipal HY relative to corporate HY bonds, over the past 40-50 years, investors appear to be getting paid to reduce credit/default risk. As you may know, this is an exceedingly rare occurrence. For individuals paying taxes of any kind, let alone those in the highest tax brackets, the benefits on a taxable equivalent basis are even more dramatic. While we do not believe the credit cycle is likely to end in the near future, we do believe investors are being well compensated to adjust their HY exposures and allocate toward municipal HY.
Due to a lack of credit review capacity or experience, many municipal bond managers restrict themselves to investing in bonds rated “A” or better creating opportunities for firms like Clinton Investment Management as our unique credit analytics and investment capabilities seek to identify stable to improving municipal issuers across the credit spectrum, including lower investment grade securities.
- Tax-Free Municipal High Yield Index illustrates yield advantage over Corporate High Yield Index
- Since 1970, Baa rated Corporate issuer,10 year rolling default rate, was 4.61% or over 14 times greater than Baa rated municipal issuers at 0.32% according to Moody’s “US Municipal Bond Defaults and Recoveries”- May 7,2014
- Current yield advantage/ratio is roughly 3 standard deviations cheap to the average since 1995.
- Investors seeking to maximize returns within the high yield sector on a risk-adjusted basis should consider adding to or reallocating toward municipal high yield.
- In contrast to peers who restrict themselves to investing only in bonds rated “A” or better, Clinton Investment Management’s unique credit analytics seek to identify stable to improving municipal issuers across the credit spectrum including lower investment grade securities.Tax-Free Municipal High Yield Index illustrates yield advantage over Corporate High Yield Index
- Since 1970, Baa rated Corporate issuer,10 year rolling default rate, was 4.61% or over 14 times greater than Baa rated municipal issuers at 0.32% according to Moody’s “US Municipal Bond Defaults and Recoveries”- May 7,2014
- Current yield advantage/ratio is roughly 3 standard deviations cheap to the average since 1995.
- Investors seeking to maximize returns within the high yield sector on a risk-adjusted basis should consider adding to or reallocating toward municipal high yield.
- In contrast to peers who restrict themselves to investing only in bonds rated “A” or better, Clinton Investment Management’s unique credit analytics seek to identify stable to improving municipal issuers across the credit spectrum including lower investment grade securities.
© Clinton Investment Management
