Q2 2022 Putnam Muni Bond Funds Q&A
- Municipal bond prices fell and their yields rose as the markets began pricing in a faster pace of monetary policy normalization.
- Although technicals remain challenged, credit fundamentals are strong and valuations are fair, in our view.
- The increased income from higher yields can help provide a cushion against negative returns and rising interest rates, in our view.
How did municipal bonds perform during the second quarter of 2022?
Despite their healthy credit fundamentals, municipal bonds succumbed to market pressures. Municipal bond prices fell and yields rose as the markets began pricing in a faster pace of monetary policy normalization.
As investors sought cash, municipal bond funds sold holdings to generate liquidity to meet redemptions. This exerted further downward pressure on prices, resulting in increasingly difficult market technicals [supply/demand dynamics] for the asset class.
For the three months ended June 30, 2022, the Bloomberg Municipal Bond Index returned –2.94%. Short-term municipal bonds outperformed their intermediate- and long-term cohorts. From a credit perspective, investment-grade municipal bonds held up better than higher-yielding, lower-rated bonds in the risk-off environment.
What is your current assessment of the health of the municipal bond market?
Municipal credit fundamentals continue to be strong, in our view. Higher employment, increasing wages, and rising property values have all served to bolster tax receipts. As a result, state and local tax collections were up 13.6% in 2021 compared with 2020. Unprecedented fiscal support and strong economic growth also put most state and local governments in their best fiscal shape in more than a decade. Finally, municipal defaults are running below long-term averages year to date through June 30, 2022, and remain isolated to the lowest-rated cohorts. As such, we believe the credit outlook remains favorable.
How were the funds positioned at the end of the second quarter?
At quarter-end, the funds held an overweight exposure to bonds rated A and BBB relative to the benchmark. The funds were slightly underweight high-yield bonds relative to their Lipper peers at period-end due to our view that the Fed’s aggressive tightening cycle could result in slower U.S. economic growth. While credit spreads widened over the period, they were not excessively wide versus longer-term averages, in our view. From a sector- or industry-positioning perspective, we favored continuing-care retirement community, private higher educations, and charter school bonds relative to the funds’ Lipper peer groups. Duration positioning, a measure of the funds’ interest-rate sensitivity, was slightly long relative to the average level of their Lipper peer groups at period-end. We believe this positioning may help the fund outperform if the year-to-date rise in interest rates reverses course.
Regarding our strategy for state debt, the funds held an overweight exposure to Illinois relative to their Lipper peer groups. We believe Illinois’s financial profile continues to stabilize, and its flexibility and credit fundamentals have improved since the onset of the Covid-19 pandemic in the United States.
The funds remained underweight in their exposure to Puerto Rico municipal debt relative to their Lipper peer groups. However, we have become somewhat more optimistic about the U.S. territory’s credit fundamentals. In March 2022, Puerto Rico ended its nearly five-year bankruptcy with a plan to restructure its debt, resume payments to bondholders, and restore its public pension system. We continue to monitor Puerto Rico debt for potential investment opportunities.
What is your outlook as we enter the third quarter of 2022?
So far in 2022, market technical factors have generated headwinds for the asset class as positive seasonal factors waned and fund flows turned negative. Although technicals remain challenged, credit fundamentals are strong and valuations are fair, in our view.
We expect volatility and uncertainty to remain elevated in the near term as stubbornly high inflation, a hawkish Fed, and the war in Ukraine continue to put pressure on the global landscape. However, the increased income from higher yields can help provide a cushion against negative returns and rising interest rates, in our view. Future returns look more promising for longer-term investors, in our opinion.
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