Transcription:
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Mike Scarchilli (00:04):
Hi everyone and welcome to The Bond Buyer podcast, your trusted source for insights into all things municipal finance. I'm Mike Scarchilli, editor-in-chief of The Bond Buyer, and today we're joined by Kim Olsan, senior fixed income portfolio manager at NewSquare Capital. Kim brings more than 30 years of experience to the conversation, having spent most of her career as a trader most recently at FHN Financial. Now on the buy side, she continues to write daily and weekly market commentary, offering sharp analysis on technical and fundamental trends, trading patterns, investment flows, and sector insights. In this episode, Kim sits down with the Bond Buyer's Lynne Funk to share her perspective on the municipal bond market. As we head into 2025, the conversation explores December's performance and the year's rocky close discusses how inflation and budget pressures are impacting state credit and analyzes the growing influence of separately managed accounts and ETFs. Kim also highlights the role of algorithmic trading and explains what issuers should know about the evolving needs of the buy-side. It's a wide ranging discussion packed with insights, so let's dive right in.
Lynne Funk (01:21):
Alright, welcome again, Kim. It's so great to have you on the Bond Buyer podcast.
Kim Olsan (01:28):
Happy to be back with you, Lynne.
Lynne Funk (01:29):
Excellent. Yes, it's been a few years actually, I believe, and actually the last time I talked to you, you were still trading, you've spent most of your career as a trader, but last year joined the buy-side at New Square Capital as a senior fixed income portfolio manager. And I guess maybe to start off, I want to kick things off with talking about year end. We're recording this the first week of January, the market closed out 2024 with some losses in December. You noted this week that the AAA 10 year Muni opened above 3% for the first time since 2010 with this higher yield range. And can you give some highlights perhaps on how December played out from historical perspective and kind of what that might mean for the first few weeks as we kick off 2025?
Kim Olsan (02:17):
Sure. Yeah, December that just passed obviously had a much different tone to it than a year ago December, when between November and the end of 2023, the market had a huge rally reversal of October's massive selloff. But this past December we wound up with yields 20 to 30 basis points higher across the curve, and that really reversed the prior several years when the performance was either flat or on the positive side. So I think there was a little bit of a defensive mindset, although the last week of the year and even just the first trading day of January, there was pretty good volume both customer buying and selling. So I think maybe the market had backed up and there are the natural ebbs and flows where actual yields come into play and people feel a little more compensated and decide to be a little bit more engaged.
(03:16):
On the supply side. For December, it wound up around $31 billion, which was a little more than 10% less than the month, so over the last 10 years or so. So there really wasn't any supply pressure, which was somewhat surprising because there was a little bit of an expectation that maybe issuers might try to bring some calendar into December rather than waiting January, February of this year. So that was a little bit of a difference for this past year. And the market tone I think is mostly supportive. I think this yield range will hold some interest, but as we've seen over the last year or two, especially since the tightening cycle began, muni buyers have been reactive to factors outside of our market. Treasury volatility being one, inflation data, some geopolitical activity, and that really comes down to where ratios settle out. If treasuries have some massive pullback on whatever impetus and munis aren't quite so reactive that way, you start to get ratios that misalign and munis get a little richer. And so that can be a drag on activity. I think it's interesting to note that over the last 12 months, the trading range 10 year MMD hit a low 2 28, which was about a year ago. And then the high for 24 was three 13, which was in November. So closed out December, just a few beeps off that November high. We've shown a little performance in the last couple of days that took it through 3%, but generally in that general market category, we're still well above 3% there.
Lynne Funk (05:01):
And when you look at that, when you think about yields versus relative value versus ratios, are investors maybe looking more at real yields as opposed to ratios into the coming into this year?
Kim Olsan (05:13):
Yeah, I think obviously the market ebbs and flows and we had a really prolonged period of extremely low rates, but ironically ratios were on the higher end as to where they are today when we're a couple hundred basis points higher. So I think for customer engagement and rather than sitting in a money market and coming out the curve and locking in some yield, I think where we definitely, where we moved to during 23 and 24 off the lows of that 20 and 21 period, I think it is a function of real yield where tax equivalents work out and are people feeling compensated on that taxable equivalent basis. If you have a 10 year trading at a three 10 and it's high quality name, but you're down in that 65 or below 70% ratio range, maybe it's not quite so relevant. But when you shave a lot of yield off and then the ratios get challenged, I think that's where the market runs into an issue.
Lynne Funk (06:16):
Okay. So looking at, we're talking 3% for a AAA 10 year when we're looking at credit a credit perspective, what are you looking at in 2025 given that Covid era federal aid is done, costs have risen via higher inflation over the past two years. Are there state budget pressures on the horizon? I know you've always looked at this when you were trading, but I'm curious how you're looking at it perhaps from a buy side perspective now.
Kim Olsan (06:49):
Yeah, I think what it comes down to is where do the cushions lineup, rainy day funds are a good barometer to see where the states are on a wholesale basis. And I was looking at this recently, and rainy day funds as measured by a percentage have increased every year, 2008 to 2019, the covid period in 2020, there was a small dip, and then 22 and 23 rebounded. The current fiscal year, there's been about a 14% increase in rainy day funds from the prior fiscal year. So I think states in particular are going to be a little more sensitive coming off the pandemic relief that they received and managing budgets to what may be some bumpier economic conditions in the next year or two to see how that all plays out. So I think overall, we've had several states that received actual upgrades. There are several that are on positive outlook for potential upgrades. You think about Connecticut, New Jersey, Illinois, those have been some of the best performing states as bidders and buyers look to the credit quality, improve budget scenarios. So I don't think it's going to be as strong as it was possibly in the last two or three years, but on a net basis, I think the rainy day funds point to enough stability that there shouldn't be a massive concern.
Lynne Funk (08:16):
So are you looking at any specific sectors that maybe you're concerned about, perhaps bullish on digging a little deeper there?
Kim Olsan (08:24):
Yeah, I would say in terms of being bullish, I think go bonds in terms of what they typically fund. There may be some reduced issuance there only because project costs have risen dramatically. The cost to build a school, the cost to build city buildings, particularly in the high growth areas in the south and southwest. In terms of additional support, I think the transportation sector probably continues to do pretty well. Airport toll roads, those lagged when a lot of the population was work from home. Now we have a lot of the return to work scenario just inherent travel, daily travel related to that business travel resuming. So I think that probably lends itself to a constructive bias for airport and toll roads in particular. I think if there's a sector, and I wouldn't classify it as the entire category, and this isn't anything new, but smaller, higher education entities where enrollments might be pressured, maybe any potential stock market effects, if there's some weakness in the equity markets and endowments of small schools may not realize the returns that they've enjoyed over the last few years. So I think it is a little more nuanced and isolated, but again, it's prudent research and information disclosure to rely on and track that if it were to come to be.
Lynne Funk (10:01):
And how about high yield broadly, I mean way outperformed IG credits this past year. What are you looking at in the high yield space? What do you think determines that performance this year particularly? Maybe if rates would fall in maybe the first quarter?
Kim Olsan (10:18):
Yeah, I think we're not so active in the high yield space. We have more of an investment grade focus, but I think if you just look at select metrics in that category, I want to say that there were maybe only five weeks of 2024 where high yield mutual funds saw any kind of outflow. And so it was highly supported during the year. A little bit curious. I would say maybe because we did have fairly generous high grade interest rates, so you can expect maybe a little more push down the credit curve when you have low rates in play as in 20 20, 20 21. But again, if we're looking at potential lower yield range during this year, I would expect that demand to continue and even grow. I think information is more rarely available. The economics of these issuers, the public knowledge around it disclosure, you can see certain programs that are dedicating themselves to high yield strategy, enjoying a lot of asset attraction. So I think the professional approach to it is probably a little different than maybe a yield of the past when it was more of a one-off type credit. I'm still following this bright line Florida issuance, and I think conceptually for transportation needs, it's a very interesting development and if you're the investor, the scale of the issues that they've brought to market across taxable and exempt structures, it's pretty compelling if you have the research and wherewithal to invest into it.
Lynne Funk (12:01):
Right.
Kim Olsan (12:02):
We've had,
Lynne Funk (12:03):
I think some of our listeners, and perhaps you're aware that The Bond Buyer gave that deal the Deal the Year and the feedback we've gotten is definitely people either really love it or love to hate it. And I think it's an interesting time though in this market where it did use really interesting structures. And you have to think that because of the need, and we're going to get into supply here in a second, but really the need of infrastructure in this country, how perhaps these types of transactions might become more commonplace.
Kim Olsan (12:40):
I mean, I remember early in my career starting out that there were, in Pennsylvania in particular, but even just nationally, there were municipal conduits used for steel companies, US Steel, Bethlehem Steel. So the municipal approach for what in some cases might be private activity debt, but otherwise publicly issued and beneficial debt. I think the market has proven it can accommodate it, and I do think that with infrastructure needs growing and the demand for a more reliable services across transportation networks, that the municipal issuer approach for these entities, the more deals get done, the more the market has a comfort level with it. And so I think that bright line set of transactions was pretty, it's a good mark in the sand as to what might come for the future.
Lynne Funk (13:38):
Right, right. Interesting. So let's take it over to supply then. We're coming off a record year more than $500 billion for the muni space. I'd say all else being equal in 2025, most expect the same if not more. As you just mentioned, infrastructure needs grow, the cost to build it also have grown. What are your thoughts here on what's coming down the pipeline?
Kim Olsan (14:00):
I'm in the camp and even before it looked like the market was going to hit that $500 billion number, so I'm in that plus 10 to plus 20% additional supply camp for 2025, which would put it around five and a quarter, $550 billion. There are deferred projects. There's American Society of Engineers, I believe it is estimates, it's over $3 trillion of net infrastructure projects and improvements that are there. The pandemic relief is mostly spent, so you have issuers that will need to use the market for financing. I also think that whatever number we work towards through the year, it could potentially grow. If we do see any meaningful rate rally and you get I would say maybe 50 basis points or more of a rally could spark some additional volume issuers attempting to lock in and also potentially look at advance refundings depending on taxable rates and where they might be able to facilitate advance fundings through taxable munis, which is a category that was really one of the few that was flat year over year on issuance.
Lynne Funk (15:15):
And then I think sometimes as much as this year, this past year was a record, you have to think about those two prior years where it was sub 400 billion in general. So we're going to take a quick break here and we'll be right back. And we're back with Kim Olsan from New Square Capital, Kim. So we're talking about supply just before the break and you're anticipating five and a quarter, five and a half. What do you think? Can we start to talk maybe about the demand side of this market, the investor side who you are working with now or you are, there's been a lot of shifts in how immunity ownership generally, but more specifically how the market's being bought and sold via the growth of separately managed accounts and ETFs. Some PEG SMA holding upward of one and a half trillion of this market, and of course much of that is retail. I guess I have a couple questions for you. I'll start off with what does it mean for the market in times of volatility? What does this concentration of the buyer in this space and this maturity range, which tends to be shorter, what does it mean for the market and for issuers?
Kim Olsan (16:29):
So it's kind of a multi-pronged approach, and honestly, I think this topic is maybe one of the two most dynamic that I'm seeing in all the time I've been involved in the municipal market. I would say the other one is the growth of algorithmic programs and automation of trading, but related to the SMA and ETF categories, I think households ended the third quarter 24 owning 45% of the market that is not quite 5% above where it was in 2022 and about 3% above where it was 10 years ago. So I think the breakdown between how individuals own municipal bonds has shifted. I saw this on the trading side where electronic trading, you could see the par amounts trading and then you can look at the transaction activity and whereas 10 or 15 years ago, we might've had individuals executing for themselves. I think now those trades are being done by SMA managers and programs at a professional level.
(17:43):
And even if you just think about the demographics of the country with an aging population, the baby boomer generation approaching or already in retirement, I think the need for fixed income and in particular tax advantaged programs will continue to grow, but you can see that playing out in the ownership. And then I think the SMA model lends itself to a little bit more stability. Actually we've seen in periods of dislocation we pull back, but then there's a massive representation from professional buyers executing on behalf of individuals where they have the expertise to look at the value in the market, and it's a little bit less of an emotional process maybe than individuals who used to be trading for themselves or investing on their own. So I think it takes away some of the gut reaction and massive pullback from the market, and instead, professional investors on behalf of individuals look at it and say, okay, we've look at this correction, look where we can get a 3% yield, a 4% yield.
(19:02):
In some cases, 5% yields have been in play over the last five or six years. So I think if you look at a historical basis, that's a pretty big shift. And then on the ETF side, massive growth. Just five years ago there was about one and a half percent of the entire municipal market was classified in the ETF space and now this is 2024 set to end a little bit above 3%. And you can just look at the growth of specific programs and structures that ETF managers are implementing, and it starts to mimic a little bit of a fixed maturity approach where you can tailor duration, you can tailor credit, and it feels a little bit more of a defined approach to investing rather than in a traditional open-ended format where it's a defined duration range, but maybe not quite so nuanced. So I think the ETF model, it's proven itself on the equity side. I think investors like it for the intraday aspect, price discovery, and just the liquidity that it does offer.
Lynne Funk (20:20):
Right. Can you talk a little bit about from moving from trading, you mentioned algorithmic trading as one of the biggest changes you've seen. Do you think this market, how has it changed? Can you talk a little bit about that just from your seat?
Kim Olsan (20:34):
It's certainly improved liquidity. It used to be not that long ago, definitely less than 10 years ago, you would expect a wider bid ask spread on a 50 bond piece or a hundred bond piece, and that really isn't the case so much when you're in the generic investment grade categories, especially AA and AAA bonds. So from an efficiency standpoint, I think it's helped market execution. It's given sellers a better bid side, and it just creates more, in my opinion, more of an equity-like execution where it's a more defined bid offer spread. You don't necessarily have the gaps that you're used to, and there is need down in the odd lot category for liquidity, both for buyers and sellers to realize a fair price and then buyers to have more of a round lot opportunity. So I think from a trading aspect, it's extremely efficient and that's where technology I think will continue to make its impact on our market.
Lynne Funk (21:49):
Do you think
Kim Olsan (21:50):
That any
Lynne Funk (21:50):
Firm can exist
Kim Olsan (21:51):
Without it anymore? I think yeah, because I think our market is big enough and diverse enough. What is it a million different. So I think there is a need up and down bulge bracket, smaller regional, there are still trading desks that focus on sinking fond bonds and non-rated credits and continuing care facilities. So I think the diversity in our market lends itself to a pretty diverse dealer community. Does automation help make a trader or salesperson more efficient? Probably, but I don't think it will eliminate the need for that human to human activity,
Lynne Funk (22:38):
Not a one for one replacement in any way. So I guess let's flip it to what should the issuer community be thinking about the buy side? I know that's a very broad question. I was going to say, should they care? And I think you're probably going to answer, yeah, right? Yes, they probably should. But I guess maybe can you talk about what is yours should be paying attention to in 2025 from what the buy side is looking for?
Kim Olsan (23:05):
Yeah, so it kind of come back to the technology aspect that I think it's a good and a bad. The good of it is that issurers can disclose periodic financial information as they're required to. They also are obligated to disclose any negative actions or activity that may affect the credit of their bonds, but I think that there's room for improvement on that. Always just the timeliness of it. As a trader, I always wanted to know about what was pending or maybe impactful to the credit, and kind of the same applies as a buyer investing for our own investors where you want timely information, you want the financial access, annual financial reporting, ratings disclosure and whatnot. And so that's the positive to technology helping facilitate all that. The downside is that technology is so pervasive that it is opening itself up to some data breaches. Almost nobody has escaped a data breach in their personal life. And so I think it's something to manage and probably the issuers will be mindful of for their investor base, and just know that if any negative event like that happens that as the investor, you'd like to know that credit finances aren't affected and that information is secure and can be rectified if necessary. So as technology improves, it also I think opens up some of these negative actions that unfortunately insurers have had to experience. Right,
Lynne Funk (24:54):
Because you said nobody really could, I don't think anyone could say they haven't experienced it on their own personal terms. So imagine,
Kim Olsan (25:01):
Right. Yeah. It's almost a fact of life with how technology or reliant we are.
Lynne Funk (25:08):
Yeah. So Kim, I guess I'd ask you, is there anything that you would want to leave this audience with that I haven't brought up? Things you're thinking about for 2025? You always, Kim, for our listeners who don't know, Kim writes a lot on this market, and I personally find it, her insights really interesting because she focuses in on something different every day. So no pressure there, Kim, but give our audience something to chew on for 2025 as we're entering this year.
Kim Olsan (25:41):
I think if I think about the strength of the market this year, I come down to two things and it's a supply and demand. Is supply going to grow to the point pending perceived or actual changes in tax provisions that would impact the tax exempt nature of our market? I could possibly see it really accelerating. And so as the reaction to that, the demand would be for higher yields, of course, to place so much additional supply. So I think if anything has been proven over the last five or six years since the pandemic onset, we were in an ultra low period low rate period then and there was decent supply issued. There was a pretty diverse buyer base. But I think if we enter a period where our market has outsized supply on any potential tax changes, then we would probably expect to see yields react.
(26:48):
And if you bump up another 50 basis points or a hundred basis points, so maybe you get too crazy to say, but maybe you get to 4% 10 year AAA spot level, and then that would probably push long bonds above 5%. I think the crossover opportunity there would be pretty large and we would see some non-traditional municipal activity happen from maybe more traditional taxable oriented accounts. So that's just something that's kind of in my head about where, and just to look at how supply builds. I think if the first quarter is heavier, then that might be a prelude for the rest of the year. The flip side is there's likely to be an upward yield reaction, and so that would be advantageous from an investor standpoint. Right.
Lynne Funk (27:46):
We didn't even get into pop
Kim Olsan (27:47):
Back, not so much from a trading standpoint managing it, but
Lynne Funk (27:51):
Yeah, I didn't delve into the tax policy stuff because it is so early in the year and we know there's so much uncertainty with it at this point. But that's not to say that everyone's, it's not on our minds for sure. But I really think your point about if it brings, somehow we have this influx of supply and yields do rise, I think that the market, maybe some folks forget there is that crossover buyer, there is the taxable interest in this market, and there's a lot of buyers out there who perhaps would dive back in
Kim Olsan (28:26):
If rates were right. Yeah. There's one sector that stands out to me, and it's Texas PSF school bonds, and so they have a pretty traditional trading range. When they get above 50 basis points or wider against the generic muni curves, then that is typically considered supply driven and some anomaly in the market, and then the credits revert back to their norm. They're dealing with a lot of Texas school districts that have fairly strong underlying ratings, and so savvy buyers will know this and take advantage of it. If I just use that as one sector where you can look at it and see where market opportunity develops and it ebbs and flows, but when things widen out, it typically is a good buying opportunity at that time.
Lynne Funk (29:22):
Excellent. Well, Kim, thank you so much for your time. It was a great conversation. I know we'll be glad to chat with you. We'll be continuing it for sure. It's always such a pleasure and happy New Year to you and to our listeners.
Kim Olsan (29:38):
Thanks again, Lynne.
Lynne Funk (29:39):
Alright. Take care everyone.
Mike Scarchilli (29:41):
We hope you enjoyed this episode of The Bond Buyer podcast. A big thank you to Kim Olsan from NewSquare Capital for sharing her deep expertise and to Lynne for hosting. Here are three key takeaways from today's discussion. One, December capped off a challenging year with municipal yields at multi-year highs highlighting a shift in the market. Investors are increasingly focused on real yields and tax equivalent returns rather than traditional metrics like ratios signaling a deeper engagement with market fundamentals. Two, we explored how various sectors are performing in this environment. Transportation infrastructure, including airports and toll roads, is benefiting from higher travel volumes while smaller, higher education institutions are facing challenges due to enrollment pressures and fluctuating endowment returns. And three, the conversation highlighted, the growing influence of separately managed accounts and ETFs in reshaping the muni market. With nearly 45% of the market now held by households, the role of professional managers is driving greater stability and liquidity even during volatile periods.
(30:53):
Thanks again for listening to The Bond Buyer Podcast. This episode was produced by the Bond Buyer. If you enjoyed this episode, be sure to subscribe on your favorite podcast platform. Rate us and check out more insights at www.bondbuyer.com. Until next time, I'm Mike Scarchilli, signing off.