How is the buy side approaching portfolio management in a post-Fed tapering, rising-rate environment? Participants will discuss mutual fund flows, taxables, dealer inventories and more.
Transcription:
00:00:10:02 - 00:00:38:29
Lynne Funk
Hi, everyone. Good afternoon. Almost evening. This is the last panel of the day. This is a take from the buy side. We have with us three experts. We have Hector Negroni, CEO and founder of Foundation Credit. We have Sylvia Yeh, managing director, co-head of muni fixed income at Goldman Sachs, and Mark Paris, who is the chief investment officer, head of munis at Invesco.
00:00:39:11 - 00:01:03:06
Lynne Funk
So welcome, guys. Thank you for coming and joining us here. So let's just get right into it. You know, I was going to when I was thinking about writing the questions for you and say, oh, this higher interest rate environment we're in and we are. But even in the past few days, of course, they've fallen a bit but I guess I'd you know, maybe, maybe, Mark, you can start us off just where, you know, we're in a higher yield side.
00:01:03:29 - 00:01:07:15
Lynne Funk
How is that affecting returns? Demand? the overall sentiment?
00:01:07:26 - 00:01:26:12
Mark Paris
Yes, sure. Thanks and great to be here. And thanks to the bond buyer and great to be on this panel with Sylvia and Hec. But yeah, look, I think last year was a fantastic year for munis, right? Incredible flows. And I think we had to pay for it somehow. So we're paying for it at the start of of this year.
00:01:26:12 - 00:01:50:24
Mark Paris
Clearly, the retail investor and ideal primarily the retail investor in this amazing mutual funds is going to get spooked when they see the stock market go down, when they see their bond returns go down, and then they when they have to watch a war on TV and then you throw inflation and the Fed into that. So, you know, you're down about 3% across high grade and high yield are about the same, you know, getting getting into this year.
00:01:50:24 - 00:02:05:20
Mark Paris
And I think investors are going to start having to think about the fact that correlations tend to get to one when you get a lot of events like this. So, yeah, you are going to have a lot of things go down and then it's a time to sort of rebalance. There's still a lot of yield in the muni market.
00:02:06:10 - 00:02:28:27
Mark Paris
I still think we're in the midst of a reopening trade, especially for high yield. I still think there's parts of high yield that can continue to get tighter Love the hospital sector as we still like the CRC sector. But the volatility is here and I think investors need to start thinking about entry points. They need to start thinking more about dollar cost averaging.
00:02:28:27 - 00:02:45:18
Mark Paris
And I think hopefully what investors have learned from the last crisis of COVID is if you run for the door, when are you going to go get back in? When are you going to get back in? And I saw too many investors get creamed at the start of COVID, and I don't know when they actually got back in.
00:02:45:18 - 00:03:05:16
Mark Paris
So you're down ten or 12% at the worst of COVID. Are you back in again? And where are your actual returns from munis in a year where 2020 munis were up three, 4% in 2021. We're up more like, you know, 5% in high yield. So my advice is, you know, investors need to stick it out a little bit more.
00:03:05:16 - 00:03:24:14
Mark Paris
They need to understand the correlations, go to one. There's a lot of global stuff going on, on top of the Fed stuff, but the credits are great. The credit market is fantastic. It's really strong. Everybody wants higher rates, but they don't want to deal with the pain getting there. And I think that's that's sort of the theme that I've been telling our clients.
00:03:25:10 - 00:03:47:10
Sylvia Yeh
I will say if I can chime in, a really interesting part of 2021 or theme throughout was the fact that Munis were killing it and we saw all of those crazy inflows into the, all the various types of mutual funds. But when you flip over to the SMA world nominal yields were so low you couldn't convince people to get off their butts and get back into the market for all the reasons they were supposed to own munis.
00:03:47:18 - 00:04:06:26
Sylvia Yeh
So while we had a great year, it was actually painful to see clients move away from what their traditional allocation would be to the asset class. So Jan, while painful, was actually pretty awesome because fixed income was cool again and we were having conversations with clients and they were thinking about starting to leg in and get their tool back into the marketplace.
00:04:07:08 - 00:04:26:27
Sylvia Yeh
And Valentine's Day, we had a ten year, had 204 ish, like we were right there and then we're faced with all this geopolitical just sadness that bring us back the other way. But to all of your points, I think this is going to be a really volatile upcoming year. And I think we are going to see actually in in our outlook too, we say the journey back home.
00:04:27:03 - 00:04:40:17
Sylvia Yeh
I think we're going to see a lot of clients start to rebalance their portfolios, maybe take off a little bit of the risk they put on in 2021 as they were chasing for that additional yield and income and kind of come back home to their their core percentage allocated to munis.
00:04:41:29 - 00:05:03:21
Hector Negroni
So one thing I take away, just as you think about us is to think about the distinction between all of our activities. Mark predominantly runs institutions open accounts and mutual funds. Sylvia runs mutual funds and some accounts. And then I'm also a hedge investor who doesn't really care about tax exemption. A whole lot more about relative value.
00:05:03:21 - 00:05:22:03
Hector Negroni
And so thats a different view. So for me, my thoughts on rates are really twofold. One is the absolute level of rates never really matters a whole lot to me because and I don't think it should matter to anybody. There are a lot absolute levels. The issue in munis is more about momentum of rates, the issue of rate volatility has been the bigger factor.
00:05:22:03 - 00:05:44:14
Hector Negroni
You know, I make I make a terrible joke that Munis is like a fat guy, something I should know about. We can go 50 yards, but we can't go 50 yards fast. Rate changes don't transmit themselves efficiently in our marketplace. And that's what we're experiencing right now. That volatility is disruptive to prices that are so discontinuous. Now, for us, it's really great because I don't really care where they are, but they're much cheaper in the Treasuries.
00:05:44:24 - 00:06:07:20
Hector Negroni
They're really attractive relative to corporates. And so I put that trade on. That's where we think the RV is in the space and we're attracting a lot of capital and interest from our institutional pension. Sovereign wealth foundation and endowment climates for that, for that matter. As we think about all forward because not everybody necessarily cares about what we're going to do, you want to know maybe what we think about Rate and how it's going to affect what you do if you're either on the issuer side or the banking side?
00:06:08:02 - 00:06:28:15
Hector Negroni
You know, I think I'd be wary of expecting higher rates. I know that we think there's inflation out there, and I won't debate whether it's transitory or not or what the consequences of the Ukraine invasion have. But but right now, we're going to get to a place at the end of this year where the nominal short term rate is going to be two to a half inflation, maybe four or five.
00:06:28:22 - 00:06:43:08
Hector Negroni
And the Fed is going to make a very difficult decision and they're going to a decision where they're going to keep raising rates or not. And I actually think you're going to your risk of seeing a massive flattening and inversion in the curve. And I think that's going to change the opportunity set for both investing and financing in our space.
00:06:45:07 - 00:07:04:05
Lynne Funk
So, hec, I actually want to just start with you on this one. Do you in terms of liquidity, you know, it's always a problem as markets forever absent, but in terms of when it's volatile, how has this last sort of 2022 intro into you know, into this volatile time affecting liquidity in this market.
00:07:04:26 - 00:07:29:26
Hector Negroni
It's the single biggest issue in our marketplace right now. We don't have a credit problem. We don't have a problem that the government's going to go in attack the exemption or not offer enough subsidy we have a market structure problem where we have a massive shortfall of liquidity providers. Pretty much everybody's crowded in one direction. If there's a reason for it to go in another direction, there's not a natural other side there's not a hedge against it.
00:07:29:26 - 00:07:52:23
Hector Negroni
And importantly, the price for the next buyer is a lot cheaper and so I would be wary of understanding that. I take note of that in that whether you are attempting to access the marketplace to borrow money or whether you're thinking about investing, you know, the your your your approach to the marketplace should take into account liquidity more than ever.
00:07:52:23 - 00:08:11:13
Hector Negroni
I was very involved in talking to the Fed in March of 2020 and April. I made the point to them we have a major problem, which is we know when the tide goes out it can just be massively disruptive in a way that's harmful to individual investors, harmful to capital formation for essential services and in infrastructure.
00:08:11:13 - 00:08:31:03
Hector Negroni
And I don't think we've addressed the problem I think we all kind of like we dodged a bullet there and they did the little MLF, which was I, you know, no disrespect to my colleagues, the Treasury and Fed who may or may not be here, you know, I don't think it was the right policy tool. Our problem in the marketplace isn't that Chicago needs to borrow money because it can't access a marketplace.
00:08:31:14 - 00:08:58:15
Hector Negroni
Our problem is when billions of dollars need to be liquefied from the long only audience, it's going to come at a great cost without some transitory vehicles or greater capitalization. And the dealers right now are under siege. The volatility that they experienced in March means that their risk budgets have been massively reduced. They're carrying very little inventory. There are days where our positions as a hedge fund feel uncomfortable in large relative to those in the street.
00:08:58:28 - 00:09:05:19
Hector Negroni
And that's that's a harbinger for, you know, for for a lot of potential dislocation. So, yes, it's something I'm anxious about.
00:09:06:05 - 00:09:33:01
Mark Paris
Yeah, I did. And look, I think the we came into this period a lot of cash mutual funds came to the market with a lot of cash that helped keep things orderly. I think Puerto Rico's going to bring a lot of cash into the marketplace, but that's just going to kind of gloss over the bigger problem. And, you know, you saw this at the start of COVID, where the market literally has to get to a very low equilibrium for people to come in and buy and it's very, very painful.
00:09:33:01 - 00:09:50:15
Mark Paris
And heck, they did nothing at the government level. I was on some of those calls, too, and I would say I thought the Fed did a great job during COVID. I wish they would. It did something for the municipal market. There were folks like us just pounding on their door. And now you kind of get we had a lot of cash beginning of year.
00:09:50:15 - 00:10:07:02
Mark Paris
Puerto Rico money is coming in big time in a couple of weeks. And I think that'll help keep things orderly. The fact that you now have a little bit of a Treasury rally, but you cannot go to the big dealers anymore and say, I'll sell you 10 million of that. 20 million of that. You know, you joked around a little bit me today that I had a big list out.
00:10:07:03 - 00:10:27:21
Mark Paris
Well, you have to stay competitive now in this marketplace. And I was never a big fan of of going that route. But when people aren't putting the capital up, things get a little bit more competitive on the street. And there are certain names that are trading. I'm not going to put a CCRC up for the bid. I'm not going to put, you know, a factory out in Iowa.
00:10:27:21 - 00:10:40:20
Mark Paris
But I think some of the on the run bonds make a lot of sense to put people incompetent in competition until somebody says, Hey, wait a minute, I'll step up and do something. I just think we're not going to find that pocket of liquidity.
00:10:41:12 - 00:10:42:01
Lynne Funk
I remember
00:10:42:01 - 00:10:48:03
Sylvia Yeh
I Remember on the desk, there used to be a trader you probably know, too, who stood up on the desk and would always say, Where are all the buyers.
00:10:49:17 - 00:11:10:05
Sylvia Yeh
Where are All the dealers? And I can say that because I do remember when I was a trader many moons ago, whether it was the auction rate crisis or other, like we were providing mortgage we were providing liquidity. And now being on the buy side in March, don't shoot me, it was kind of fun. It was. But the dealer is the typical banks that you would depend on.
00:11:10:12 - 00:11:25:07
Sylvia Yeh
Dealers who you would depend on weren't there. They're more of like facilitators than they are taking on risk. I would actually say they probably more cause more of a disruption to the market than anything else because they have conviction and they go with it and all of a sudden, oops, but too much. Where do you want them?
00:11:25:17 - 00:11:44:10
Hector Negroni
I think it's I was going to make this point you exactly went into one of the things I don't think people want to be that. Yeah. But one of the things that I don't think people understand is, you know, actually it's pretty funny. In the last six months, some of the most patient investors in the marketplace have been the mutual funds and the money market funds.
00:11:44:12 - 00:12:06:15
Hector Negroni
And that's not always been historically the norm. Usually the cash sensitivity they've had to outflows have made them more trigger happy in terms of either chasing bonds or selling bonds. And I think they've conditioned themselves to be more patient, have more cash buffers. Where there's more there's there's there's a much shorter fuse on the the kind of liquidity providers prop desks.
00:12:06:25 - 00:12:23:25
Hector Negroni
Some of these are some of our peers in the hedge fund space who are a little quicker to say, oh, the January effect didn't happen, let me get to my bonds now. And they really create an artificial amount of NAV volatility for you guys, I would imagine in terms of causing, you know, a high degree of, you know, perceived, you know, perceived risk.
00:12:23:25 - 00:12:45:19
Hector Negroni
Well, maybe it is a risk. And I think what in all that, what it means is pre-trade price transparency is just getting harder to come by. And it means professionals like me. I do well with it. But like if you're an investor of your issuer, come to the marketplace once every so often or if you're an investor only investing every once and so often, like it's not clear where you can transact in the marketplace in the risk you're taking on transacting at your price.
00:12:47:19 - 00:13:04:25
Lynne Funk
So I would like to go back for a second then just to Mark, you've touched on what could have the Fed done more. Is that both of both of you to have some opinions? I know I have been speaking to you before. So would you would you want to say, like, should the Fed really be have like a secondary market liquidity facility?
00:13:04:29 - 00:13:25:20
Mark Paris
I'll sort of look, I think the Fed did a lot, you know, March 24th the March 26th liquidity facility. I think, you know, they threw an amazing amount of money at the problem I'm not in the camp that Jay Powell mismanaged this and now we have this terrible inflation. He had to throw money at a problem. And the way to throw money at the problem is you take rates to zero.
00:13:25:21 - 00:13:51:02
Mark Paris
You do, you know, quantitative easing. So I think all that was good. I think where Hector and I were coming from and heck and probably more elaborate better than I but we had phone calls with eight phone calls with the White House, with different Senate offices with zero but with some different types of of folks saying, you know, the muni market is open, it is trading and it is trading viciously down and no one is there to stop it.
00:13:51:02 - 00:14:17:06
Mark Paris
And there are mutual funds. Look, there there's been you know, headlines that mutual funds had to go to their parents, you know, parent companies to get money. We were lucky enough not to have to do that. But, you know, there was a lot of people reaching out because they couldn't get an orderly market. So I think, you know, my hope and help me out here, my hope was that they could have come in and said, hey, we're going to do some backstops the way we did to the corporate market.
00:14:17:06 - 00:14:18:10
Mark Paris
Maybe we'll buy some new things.
00:14:18:21 - 00:14:40:18
Hector Negroni
Yeah, it's all about exigent circumstances. They existed for the purpose of liquidity in the corporate space. It's hard to imagine they didn't exist in ours. You know, I think we all know a story. I remember. I know maybe it was March 23rd, not to be exact, but we're like, you know, there was a late on call of a bond that traded in maybe a 59 our size that was tax exempt from a large, well-known institution.
00:14:40:29 - 00:15:02:10
Hector Negroni
It probably traded, you know, probably traded 200 basis points above the 30 year. Okay. That's a bond that normally would have traded at or below the 30 year yield and that's read the $0.03 price. But then immediately following that 500 bonds at the same issuer sold 20 points cheaper. That level of liquidity resets NAVs when there's not a lot of prices.
00:15:02:10 - 00:15:23:21
Hector Negroni
The pricing services have limited choices for how they can determine where to independently price stuff that read into a broad matrix framework, which means a handful of benchmarks can reset pricing and misinform where the actual clearing price is for broad risk in the marketplace. And so what I think would be better is no differently than the corporates is focused on index.
00:15:23:21 - 00:15:40:22
Hector Negroni
Now, we don't have a lot of indices in a marketplace and we can debate at length how to build those. But taking benchmark securities, which we all viscerally know what they are and saying they'll provide regularly, you know, liquidity for those. What it does is they should be forcing investors, they should be squeezing investors out of benchmark liquidity.
00:15:40:28 - 00:15:43:16
Hector Negroni
Why? Because it will force them to take risk in the rest of the bonds.
00:15:45:23 - 00:15:56:12
Sylvia Yeh
I would kind of take the not the other side, but just for point of discussion here. We had three really bad days in March. I remember them three by 50 basis point. That's no, it was.
00:15:56:12 - 00:15:56:25
Lynne Funk
Three.
00:15:58:13 - 00:16:16:06
Sylvia Yeh
And we snapped back pretty quickly and I don't think are more I mean, I can go either way at the Fed. I look at where we are now and munis broadly from a market perspective and from a credit quality perspective, we're pretty okay and we can name all the states and issuers. I mean, we just mentioned Puerto Rico where all that money's going to come from our market snap back.
00:16:16:06 - 00:16:28:14
Sylvia Yeh
And why is that? Because of all the different buyer bases that have come into our market as we look to reset price, go through the price discovery where the traditional backstops weren't there, I mean, didn't last as long as it could have.
00:16:29:00 - 00:16:47:21
Hector Negroni
That's that's the point. But one of the reasons is, is we got absolutely halo effect from their efforts in corporates. I mean, that spilled over into taking the risk out of the taxable space, which when people can that focus on capital tax exempt. So it's a bit of both. You're right. You know, this is a topic I like to preach about because I worry about our market structure all the time.
00:16:48:00 - 00:16:51:05
Hector Negroni
But yeah, it didn't destroy us. We're here live and you probably made a lot of money.
00:16:51:29 - 00:16:53:02
Sylvia Yeh
Our clients made a lot of.
00:16:53:17 - 00:16:55:18
Hector Negroni
That's it makes you and your clients who are part of.
00:16:58:22 - 00:17:20:13
Lynne Funk
So talking about let's let's talk about some of the maybe the growth of of this investor base. But changing investor base seems ETFs. What are you. So we you actually recently were speaking about exams and that kind of growth and how is that playing a role? I mean, are these are they going to grow this year? Is that growth going to continue?
00:17:20:17 - 00:17:22:27
Lynne Funk
Can they can they hold up a part of the market?
00:17:23:19 - 00:17:40:04
Sylvia Yeh
So SMEs are tricky in the sense of we don't all report how many assets we manage. So we kind of try to like to keep people in the dark. And I don't understand why, but from the numbers that I have, it seems that we've grown at least 66% since 2013 is what I'm told I could be off by, who knows?
00:17:41:04 - 00:18:00:26
Sylvia Yeh
But I think if we rewind back to the financial crisis and we learn from our mistakes, whether it's now and we're talking about learning from the COVID crisis, but we rolled back then listening to our clients, we're looking for then and trying to respond to their pain and their desire to speak to somebody. That's how the S&P market kind of started and how it evolved.
00:18:01:03 - 00:18:20:08
Sylvia Yeh
And that really hasn't changed today. And we've seen, which is why I said it was fun during COVID that we were able to put client money to work because that structure worked, right? It's not about selling product to clients anymore. It's about determining the right solutions for them. Right? Clients want something personal for them. They don't don't choose me.
00:18:20:08 - 00:18:46:26
Sylvia Yeh
I have mutual funds, too, but it's not a one size fits all right anymore. And that's why I think you're going to continue to see SMEs grow and grow and grow. And even if we just look at the rotation from the brokerage managed assets, the old school way and that migration to managed assets in smart format, if you look at we talk about how we access to market, I remember like as an individual doing brokerage trade and being able to get to the market, you can't do that anymore, right?
00:18:46:26 - 00:19:07:28
Sylvia Yeh
So the market has kind of changed and I think Smart is really and I'm biased but highlight the best in what we've seen from the various products. I think we took a bit of a hit last year in growth. And again, I go back to the nominal rates. Mr. Client sees a trade or two or three in the résumé, and they're looking at how much they're paying in fees and they want to strangle the person who did the trade.
00:19:07:28 - 00:19:28:13
Sylvia Yeh
And I just point the finger that's going to change now that rates are going up because we're reminding them why they own munis. And again, I can't even stress enough the number of phone calls that we're having again, because that is coming true and that is holding true again. And whether it's information that's becoming available in the marketplace, the transparency is that we're asking for upon issuers.
00:19:28:21 - 00:19:50:03
Sylvia Yeh
This is all in turn to provide better distribution, better investors and ultimate pricing for all of you on the on the issue inside. Right. We're looking for a partnership here on the ETF side. Yeah, there has been growth there. It's cheap and quick access to the marketplace, but it's not apples to apples. You can't compare an estimate to an ETF into a mutual fund.
00:19:50:12 - 00:20:12:12
Sylvia Yeh
Mutual fund investor is all right. Like the big elephant in the room. They're the only investor in our market that has to buy municipal bonds. So they basically are in the driver's seat. They when they have money, they need to put to work. The inflows are driving where prices are going and then the reverse. The neat thing about SMS and you mentioned it, we can be patient, we can be patient, we can be flexible.
00:20:12:12 - 00:20:20:15
Sylvia Yeh
There's always something that we can do. There are always phone calls that we can make. You don't see that type of power in the mutual fund complex or ETF complex for that matter.
00:20:20:16 - 00:20:37:04
Mark Paris
Yeah. I think if you look at the way the market is evolved when we first have the crisis with the insurance, if you're a financial advisor and you've got to sell individual muni bonds, which is the way we all probably got introduced to the muni world 25, 30 years ago, at least for me, you know, they don't want to do that anymore.
00:20:37:04 - 00:20:55:18
Mark Paris
I mean, Puerto Rico was a bond that everybody could own and then boom, you know, you have the Chicago School Chicago District, so it's a lot easier to go this route. I look at, you know, what it's done for the marketplace, look at ratios within ten years, really rich and it's going to stay rich because the semi monster needs to be said.
00:20:55:18 - 00:21:19:03
Mark Paris
We have Esims at my shop, too, so you've got a good place to look for you. Know, I've heard a lot of liquidity. Just talk today. If you worry about liquidity the day you need liquidity, you just made a huge mistake. You better think about liquidity when you're creating your portfolio and in doing that, hey, now I know that there's a big ETF market out there and what is the ETFs based on indexes, passive investing.
00:21:19:10 - 00:21:35:28
Mark Paris
So I almost kind of have to think about like a taxable investor. I would say taxable investors aren't just, you know, closet indexers. They've got mothballs in their pockets. They're right there on top of that index, right? So now I want to own some stuff that's in the index because I know I have liquidity for the ETFs. I want to own some paper inside of ten years.
00:21:35:28 - 00:21:55:09
Mark Paris
And when I look at issuers, look how those new issues just get gobbled up for high grade paper inside of ten years just so fast. So it's changed some of the ways, you know, you don't have 85% ratios in the ten year space. You have them in the seventies because we're all trying to invest high grade ten year and in paper for SMA.
00:21:55:10 - 00:22:04:00
Mark Paris
So it's definitely changed the dynamics of the way you think about the market and it's also enhanced the way you think about liquidity because you want to have stuff that trades ETF wise and SMA wise.
00:22:04:00 - 00:22:42:21
Hector Negroni
And so one of the things that's complemented this breadth of participation are diversity of participation in the marketplace has been the growth of taxables because it's taken the place of issuance, which may have come as tax exempt issuance or not, depending on use. But importantly, it's broadened the universe. And I think it's turned its it's turned a lot of people who focus on either regulatory capital sensitivity or, you know, sovereign solvency to, you know, measurements or things where they're things where they're they're they're rules around what they can invest in and, you know, are getting these into a narrow set of things.
00:22:42:21 - 00:23:03:05
Hector Negroni
And we've delivered this expansive path for them. And historically, they haven't been attracted to because it was too small or two to two insignificant and I think we've had a really great participation from the global investor. And I know you guys have separate accounts with large not just individual investors but, you know, large institutions insurance companies and others who give you capital.
00:23:03:12 - 00:23:21:26
Hector Negroni
And I think that the broader you know, I always kind of I can't see who's here really. But, you know, I know if you've heard me speak ever, I tend to repeat this one thing, which is the biggest mistake in the municipal market to make is we continue depend upon drawing from one capital source and that's individual taxpayers in the United States.
00:23:22:11 - 00:23:37:15
Hector Negroni
And that's just silly. Like, I'm sorry, I don't want to have like the best infrastructure around. Well, why don't we draw from like the most competitive pool of capital around? Like, you know, we should be in a global presence out there now that has a cost. And there's you know, that's an oversimplification, but we should welcome diversity in our marketplace.
00:23:37:15 - 00:24:00:12
Hector Negroni
And I think it's common. It's complemented a lot. It's taken a lot of pressure off the long end. It's actually brought people in to be kind of a clearing bid for longer duration risk. And I think it's it's important, frankly. I think it's a big part of our future because somehow, you know, the needs to finance what we have in the forward aren't going to overwhelm the taxpaying capacity or certainly come at a cost at the margin over time.
00:24:00:22 - 00:24:05:18
Hector Negroni
At some point, I don't know where that tipping point is. Maybe we're far from it and you want to have diversity from that capital base.
00:24:07:00 - 00:24:14:06
Lynne Funk
So, Hector, you definitely didn't read my outline because I was going to ask you about taxables. You stole my thunder.
00:24:14:08 - 00:24:14:28
Hector Negroni
There was now like.
00:24:15:20 - 00:24:40:11
Lynne Funk
There is an outline. But but to go on that, though, we've seen an 80% drop in February year over year in tax rules. And I know that that's very likely to do with just everything that the volatility but do you still see them having some legs here? I mean, if once interest rates like the Fed hike rates and then it's like, okay, a calm settles in and here's where we are sort of issuers come back.
00:24:40:11 - 00:25:02:17
Hector Negroni
The curve matters a lot. And so if our marketplace can get to where tax exempts are, you know, not as attractive as refinancing and taables, you know, there's an arbitrage to be had there of a large portion of what we saw in the taxable space was, you know, that much could come as advance refunding bonds. And I think issuers got comfortable with it.
00:25:03:13 - 00:25:26:01
Hector Negroni
The taxable universe, I still think is best for large index oriented issuers that would otherwise, you know, smell and look like corporates making on marketplaces, looking more like a benchmark universe to, you know, the global investor. So I think that there's an opportunity for it to continue to be large you know, I don't know. I'm going to tell you, I'm not that bullish on taxable supply growing a lot this year.
00:25:26:14 - 00:25:41:11
Hector Negroni
I think there's a window where it could grow. But I think I think the participations important, we just I mean, we just made 200 billion of them in the last year. You would know the demand at no more exact than I would. But, you know, in the neighborhood of 200 of them in the next two years, like that's a lot of risk to move around.
00:25:41:11 - 00:25:59:05
Hector Negroni
It's been part of the ag index. So it matters and it's helpful. It's not sure if the supply is going to be picking up in the large sum. I do think I think there's a whole opportunity for taxable financing in smaller bespoke projects. You know, we've launched a whole activity around investing activity around that for a local infrastructure.
00:25:59:15 - 00:26:07:13
Hector Negroni
Everybody thinking about private credit applications, you know, but that's a little bit of a different that's not the run in the mill, meat and potatoes, you know, muni space.
00:26:07:20 - 00:26:27:16
Mark Paris
But it's a different ballgame, right? You have to educate so European investors aren't used to doing infrastructure the way we are, right? They like to do private infrastructure and they'll always ask what corporation’s behind that water and sewage. You'll know it's a water and sewer deal. You know, it's owned by the municipality. And so what we find is, you know, we've done more probably in Asia than in Europe.
00:26:27:23 - 00:26:47:16
Mark Paris
There's a lot of education that goes into getting that investor, you know, up, up to speed. But then when they are up to speed, they see a really good diversification. Right? I mean, you've got a war going on that doesn't necessarily affect taxable munis, you know, whereas their corporate bonds are affected when the equity market moves, the corporates are affected.
00:26:47:16 - 00:27:08:24
Mark Paris
They have so much corporate exposure. This has a little bit different look to it, not only from, you know, the the equity side of things, but from the rate side of things. Taxable munis, move a little bit. So I'm hoping investors continue to open that up. I don't think they're changing any laws. I think we're still going to have a situation where the only way to refund yourself is to go into the taxable market.
00:27:08:24 - 00:27:11:01
Mark Paris
But I agree, we're going to get lower supply this year.
00:27:11:01 - 00:27:32:09
Sylvia Yeh
And well a couple of things. Just thinking about taxable overseas brand recognition is huge, which is why the big names are able to move over there. Right? We call it what it is. I would not discount the involvement of the SMA market in taxable munis, especially for those bespoke names that are not benchmark eligible. Again, ten years in, in is kind of where we play.
00:27:32:09 - 00:27:50:20
Sylvia Yeh
And if it's issuer A that comes tax exempt that now issuer A that comes taxable it's still the same underlying credit. Do the math. If the math makes sense, it makes sense for your client. So I wouldn't totally discount SMAs. I will say not all SMAs are treated equal and don't have the flexibility to bounce back and forth and tax exemption taxable.
00:27:51:03 - 00:27:58:25
Sylvia Yeh
Again, that's, you know, maybe part of what we do which is which is a new differentiator but there's opportunity there for that buyer base to continue to grow as well.
00:27:58:28 - 00:28:02:18
Mark Paris
We've launched a tax that we're assuming that actually attracted pretty.
00:28:02:18 - 00:28:04:19
Sylvia Yeh
Good assets by copying me for.
00:28:05:11 - 00:28:07:25
Hector Negroni
I don't know the name brand thing was kind of a low blow, don't you think?
00:28:07:27 - 00:28:08:23
Sylvia Yeh
Sorry. It's true.
00:28:09:13 - 00:28:29:01
Hector Negroni
But it is. No, it's a big it's a big factor. I find. I find when we're on the old space, walking into the room to raise capital, you know, segment a minute when we go into the room, like my biggest competition is in the four or five other municipal hedge funds that are out there or it's really that like somebody walked in there who isn't in our space is so yeah.
00:28:29:01 - 00:28:42:12
Hector Negroni
Municipal throws up on itself once a year. We got it, we got it taken care of and they don't appreciate that. There's a really, really interesting opportunity to harvest from our space. So education impacts all of us as we look to diversify and expand across the globe.
00:28:44:16 - 00:29:03:00
Lynne Funk
So I think maybe this might be a good time. I know everybody's talking about ESG, but I think it's a good segue way though, right, for taxables as in the telling that story how do you how are you as investors, you know, looking at ESG in that space? How are you telling international investors since they are that's what they're asking for and they want that correct.
00:29:04:05 - 00:29:04:21
Mark Paris
To start.
00:29:05:28 - 00:29:34:17
Hector Negroni
So I usually have to give them like my disclaimer like ESG is not an asset class. ESG is not an investing strategy. Those have other names. There are things called sustainable bonds and social bonds, green bonds. ESG is simply an analysis of factors that relate to environmental, social and governance factors. And you do the analysis for the purpose of either mitigating risk or arguably looking forward to aspirational outcomes.
00:29:35:13 - 00:29:56:19
Hector Negroni
That also doesn't mean it's impact investing. Now, we make this all conflated. Actually, I think the MSB has put forth a request for comment on this, and I think it's really frankly pretty brave of them because the MSR B doesn't really have jurisdiction over a lot of people in our space. They don't really regulate the issuers particularly they regulate.
00:29:57:11 - 00:30:20:22
Hector Negroni
They don't really regulate the investors, they regulate the broker dealers at the margin. It's oversimplifying it a bit. But the truth is what they're trying to do is, hey, let's clear up the cacophony that's out there. And I think the most important thing we can do is all come to an agreement on what we're saying, especially as investors because what we're asking issuers to do either provide a state data, you know, I've been at more than one discussion where five investors all say, well, you got to give us more data.
00:30:20:22 - 00:30:40:21
Hector Negroni
And the the issue is, what do you want? I mean, what exactly do you want and why do you want it? And how do you organize what you want? I think it's fair for them to ask how to create conventions and how do we create taxonomy to make sense. So I think the assessment of ESG factors is of critical importance for investors globally.
00:30:41:08 - 00:31:11:16
Hector Negroni
It's also important for issuers who have to incorporate it into their budgeting. It's integral to what we do. We're mostly mission driven to begin with are the purposes of our issuance is mostly mission driven. So as a result, those factors, VIS and G have something to do with it. And so what I think is the most valuable thing when we care about is coming to a common understanding on what are the what metrics we can use to kind of evaluate ESG so that we're getting information and comparing information on kind of as common a basis as possible.
00:31:13:04 - 00:31:38:11
Hector Negroni
You know, my investors are mostly non-U.S. institutions and they have long been focused on the profile, but they're also focused on issues around impact. And they focus on reputational issues of like, you know, what's your carbon footprint? But it can be pretty conflated. I think one of the most important things about talking about it in general is making sure each one of us identifies how it relates to us and what we're asking for, what we're saying, because I think it's a word that's used all too broadly.
00:31:40:00 - 00:31:58:04
Sylvia Yeh
A quick comment on that, too. And I don't know, maybe some of you all know about the buy side initiative that's taking place in the marketplace right now, where about half a dozen of us came together basically trying to organize a search for information around us. I kind of feel like we think that there is good information out there with E.
00:31:58:11 - 00:32:22:18
Sylvia Yeh
I think that G, we can all come to our own independent decisions on there's enough information that's just made available. S is kind of tricky and it's challenging to kind of to talk about. So this working group came together to basically put together a survey for our issuers saying this is what we think is important and what we want to be able to put together message and build upon so that we can deliver what our clients are looking for.
00:32:22:26 - 00:32:40:00
Sylvia Yeh
So to your point of what do we want and what are we looking for? Because we're asking for data all the time. I actually think that's a step in the right direction and I applaud the MSR. B, I'll take the other side of your braveness for coming out to the market participants and asking us to engage as well because the only way this is going to work is if we all come together.
00:32:40:00 - 00:32:48:11
Sylvia Yeh
It's all about partnership to ultimately deliver to clients what they're looking for, which ultimately delivers to you. Issuer is the price benefit that you're looking for.
00:32:48:29 - 00:33:10:03
Mark Paris
I welcome that you know and conflated is the word right in net zero because how do you get the net zero information from a muni issuer that that's going to be a difficult thing too. I think Europe is way ahead of U.S. investors. We do have an impact fund and you know, it's a small fund. We're trying to build it up.
00:33:10:03 - 00:33:26:07
Mark Paris
Well, we try and tell people is, look, it has to still be a cheap bond. It has to still fit the parameters of what I want to do in the fund duration coupon maturity, all that kind of thing. And then it has to kind of go through the screening. But I think, you know, we all have our own ways of looking at ESG.
00:33:26:19 - 00:33:46:04
Mark Paris
I think the muni market's clearly behind. But even when you go to your Europe, you get that conflicted answer of did you look at this, this and this? It's like, well, no. But, you know, we had somebody asks about the death penalty this last week. Well, there's still a lot of states that have the death penalty on the books.
00:33:46:12 - 00:33:56:07
Mark Paris
They just have sort of, you know, banned it or whatever. So how do you look at something like that? And every question kind of comes up. And when you said conflated, it just hit me.
00:33:57:04 - 00:34:20:22
Hector Negroni
I would say two things. First of all, like the reason most of Europe especially is more head than us isn't better or worse. It's it's it's it's a structural governance issue, like most of the European economies tend to be socially controlled at the central government and the regulatory regime works from the top down across. Everybody was in that in that hierarchy that means investors issuers and everybody participant is regulated simply with the exact opposite.
00:34:20:22 - 00:34:42:29
Hector Negroni
Everything's Bottom-Up. I like to joke every school district in Texas thinks there's no country right and we are way bottom up. Nobody thinks they have the same set of rules that apply to them. And so the consequence of that, it creates a lot of fragmentation, heterogeneity. We live for that. However, if we're going to make any progress in trying to homogenize how we talk about this, we have to find some common metrics as we do that initiatives.
00:34:42:29 - 00:35:00:26
Hector Negroni
The next one I know of, you know, I think it's great but I do think, you know, I think it's a challenge for the issuer community to kind of lead on it. It's hard for them. It's both politically and resource. It's politically challenging and it's resource challenging. I always tell us you're just tell us your story. You already know you've done a story.
00:35:01:02 - 00:35:21:29
Hector Negroni
If people are doing something that addresses something other risk or something aspirational, largely, they've already done the work to memorialize it. They've done the feasibility study. They they've checked out whether there's going to be damage or improvement or whatever. Like communicating that in some narrative, I think is a big would be a good start. You know, I'm not saying that's the end result, but it's a good place to start.
00:35:22:08 - 00:35:46:15
Hector Negroni
I just the one thing I would caution on is because I do disagree with you, maybe unintended at the end, is this isn't a value proposition to lower your cost of funds. This is a prerequisite to raise capital if it five, ten, sometime years. Now, if you're if the issuer community and if the disclosure around the factors aren't being made, it's going to start to be penal.
00:35:47:11 - 00:35:54:03
Hector Negroni
You're going to get penalized for not doing it rather than rewarded for having done it. It's going to be the benchmark in the convention around access to capital.
00:35:55:17 - 00:35:56:21
Sylvia Yeh
You said it better, Hector.
00:36:00:06 - 00:36:31:03
Lynne Funk
Well, let's talk a little bit more broadly about credit, because obviously you both two of you have a set of, you know, credit in muni space is better than it's probably been in quite some time, you know, due to an influx of federal aid, obviously. And more is coming from the Infrastructure Act I guess two questions. Do you can you be more selective perhaps now in credit selection as yields have risen a bit like as there's high yield now going to be a little yield me?
00:36:31:28 - 00:36:48:24
Lynne Funk
And then the other question is, is I guess are there pockets of credit that perhaps we're wearing Rose-Colored glasses right now coming out of a pandemic, hopefully coming out and issues have more tax revenues. Their credit picture is better, more federal aid because there pockets of the industry that maybe we need to look at a little more closely.
00:36:50:08 - 00:37:09:21
Mark Paris
That's a lot of question. Well, I'll start because, you know, about two thirds of one third of our asset is high yield. Look, a tremendous amount of money, right? A trillion, six or a trillion seven came into a $4 trillion market. So that's going to obviously lift up all the credit. But it's what I always get worried about is everybody here is that credit's better.
00:37:09:21 - 00:37:30:05
Mark Paris
And then everybody in the small high yield issuer area can get away with covenant laid, can, you know, get away without a mortgage, no debt service reserve fund. And, you know, that was starting to definitely happen towards I'd say the latter half of last year. We saw more and more of that, not that we didn't see it in the first half of the year.
00:37:30:12 - 00:37:59:22
Mark Paris
It brings to light the skills of old Muni guys and gals like us relative value. You know, relative value is really the call now because credit is not necessarily given, but you can probably get through the credit, you know, pretty quickly and you look at credits that got really hurt, pre-COVID, Chicago schools, you know, some of the some of the things in the marketplace that really got hit hard and got all this money, you know, and kind of came back.
00:37:59:22 - 00:38:06:01
Mark Paris
So I've been saying all along really since COVID hit now that the money said this is a bond picker's market in munis.
00:38:06:01 - 00:38:06:15
Hector Negroni
You.
00:38:06:18 - 00:38:31:27
Mark Paris
You really got to dust off your old, you know, relative value skills, your relative basis skills, decide how you want to, you know, kind of create your portfolio. Look for pockets when too many people are selling the specifically one name, you know, that's going on. But I do believe that the enhanced credit is giving us a hand here in the whole liquidity side of things because we don't have to worry about an event.
00:38:32:04 - 00:38:52:11
Mark Paris
We don't have to worry about Puerto Rico, Jefferson County, you know, going back over a decade ago when California had problems. And I think that is giving us a good feeling of, all right, that stuff is on the side economy is nowhere near recession. You can argue maybe the Fed's going to move too much, but that's way too much down, down the line.
00:38:52:11 - 00:39:09:17
Mark Paris
But I think what it has done is say, hey, let's get back to relative value investing and, you know, coupons matter. And I think that's that's been a big deal in the marketplace. You know, we saw Tyus get blown out a couple of weeks ago in threes, were getting real close. So what kind of coupons do you want on stuff like that?
00:39:10:12 - 00:39:39:24
Sylvia Yeh
And I also think from an inmate perspective, I think we're all generally cautious about talking about atoms and high yield together because there's a lot more downside than there is potential upside in there, especially if one individual credit goes wrong. But what we've seen and I think I mentioned this earlier, in in 21 was that run to make up for the income that we've lost and a slight overweight in high yield and it was free money free borrowing everybody wins you know grandpa pals coming in like that mentality and things will break again.
00:39:40:00 - 00:39:56:22
Sylvia Yeh
And I do have that concern for the less sophisticated shops or the individual retail investor who did go out there on their own to you know chase the rally they saw because the pain will come LP it slowly and it might not be like an immediate event like we were talking about but there is that risk out there, too.
00:39:56:22 - 00:39:59:06
Sylvia Yeh
That could hurt the perception of the asset class going forward.
00:40:00:09 - 00:40:19:10
Hector Negroni
Yeah, I generally at the margin, I spend most my time a little more focused on structure. I do think like structure is where the the RV is most for what we do, you know, because I think the return hurdle that we have for investing a credit is pretty high and there's probably not a lot of things that meet every turnover that makes sense from an underwriting standpoint.
00:40:19:10 - 00:40:41:03
Hector Negroni
And so the return home was better meant by trading RV and structure for the most part, it's probably brought over, you know, simplification, but it's probably true. I do worry about what to avoid you know, I have this building thesis that The Post-Pandemic, while many things accelerated and change and we are example behavioral like what foundations of weakness.
00:40:41:03 - 00:41:11:25
Hector Negroni
You know, what cracks in foundation did it show up and we think a little bit about like you know where there's greater income inequality less less modernization with respect to infrastructure like broadband etcetera where there's been a demographic shift. You know I worry about those credits to, you know what would have been regarded the rural credits of yesteryear which aren't today there are just places where they're just, you know, they're just as population's been massively declined there's not really an economic base there.
00:41:12:14 - 00:41:29:23
Hector Negroni
And COVID, they haven't benefited from like a migration from one metropolitan area to them. And so I think of areas you know, in the kind of mid-Atlantic, kind of the central centralized states, but they're not big issues. But I do think they're going to get, you know, tend to tend to be small issues. That's where I think some will be some pain.
00:41:29:29 - 00:41:53:04
Hector Negroni
And then I worry about the people who are really who aren't doing or aren't prepared for for climate, for for climate risk, you know, severe storm is more than anything it think about the Texas issues that just kind of cropped up. And the consequences, though, and and then somebody mentioned earlier being are like crypto you know not not cryptocurrency like cyber theft cyber it's ever stuff is rattles in my head every day.
00:41:53:04 - 00:41:56:24
Hector Negroni
I just don't even own him I don't know how to guard against at risk.
00:41:57:11 - 00:41:59:20
Mark Paris
No I don't think anybody's that.
00:42:01:15 - 00:42:22:03
Lynne Funk
Well what about infrastructure? You know I know there's an infrastructure bill 550 billion do you do you all have any thoughts on how that might help to grow your industry or is it going to hurt? Are there other ways that it's going to benefit the municipal industry? And, you know, we haven't seen before.
00:42:24:02 - 00:42:24:12
Mark Paris
So in.
00:42:27:14 - 00:42:48:08
Sylvia Yeh
So many different ways to go about this. Well, I think it helps the industry. Yes. I think giving different ways of raising money and funding diversification on on how different types of securities are going to come to market, whether it's taxable if advanced refunding is come back, if we bring back a version of ads. I actually think all of that is really neat and healthy for a marketplace.
00:42:48:15 - 00:43:11:22
Sylvia Yeh
And I think to the point of diversification with buyers and investors helps draw more people to our buyer place a buyer's market investment place. The the amount of time it's taking to get here, I think is just puts such a drag on trading and just level of focused. It's hard to even imagine that anything's going to happen this year.
00:43:12:15 - 00:43:33:15
Sylvia Yeh
Right there are bigger priorities, whether it's overseas, whether it's inflation, whether it's just how many hikes we're going to have, people not agreeing. It's going to get stuck and nothing is going to happen all over again. And who ends up hurting because we can't get our act together again. But I think if we can purposes there the need is there.
00:43:33:15 - 00:43:38:19
Sylvia Yeh
And I think the market would welcome the differentiation, diversification that outcome would bring to us.
00:43:39:08 - 00:44:03:28
Mark Paris
Yeah, I've been quoted as saying it was infrastructure lite. 300 million of it, a trillion with a billion of its oh was already earmarked for highways. So that was kind of out of the mix anyway. There is a lot of direct funding in there. You know, I remember watching CNBC one day and the mayor of Cincinnati was in front of a bridge and he said, we're going to get the money and we're going to, you know, replace this bridge that's not getting bonded out.
00:44:04:28 - 00:44:29:20
Mark Paris
So I don't think it's going to drastically change anything. I was always hoping for a bigger infrastructure bill when Trump became president in 16, inviting president to this is what they said they could agree to and this is how they agreed to it. So I've been really disappointed in the effort to to go do that. There's no question in my mind, though, and maybe it disagrees a little bit because I know you do more private stuff.
00:44:29:23 - 00:44:45:18
Mark Paris
The muni market is the place to do infrastructure in America. That's the place to do it. We have the tools. We don't need too much intervention. We just need a little bit of a government push. And I just don't think the government has done the right bill the right way to get that push wasted effort.
00:44:46:03 - 00:45:08:20
Hector Negroni
Yeah, I mean, I think if there's any conclusion I make from the lack of progress on policy is we're kind of an afterthought. I mean, that's probably an understatement. And, you know, we we're we're not we don't have a we don't we don't have a very high priority within the federal kind of corridors with respect to organizing policy.
00:45:08:20 - 00:45:31:20
Hector Negroni
Well, towards, you know, the best outcomes. I mean, they fail, which is not like like addressing, you know, state and local finance needs are very high on the list of priorities and there's probably a whole host of reasons for that. And so it's just probably just I see it all the time. Like generally speaking, when the federal government is getting involved in our marketplace, I'm really, really really unhappy about it.
00:45:31:20 - 00:45:54:25
Hector Negroni
Can they generally do more harm than good? And so that's how I think about the policy. I will say and Mark alluded to it, I do think the one thing that was interesting that came out of the bill was this idea of pre-development capital, which is at risk capital for issuers. So sometimes there's a project that is just beyond in issuer's capacity.
00:45:55:05 - 00:46:19:01
Hector Negroni
It's missing kind of a step or sequence that they're not willing, they're not comfortable putting capital at risk for. So the way to oversimplify it, it's kind of like at risk capital, either to acquire land or to do some kind of study for something that may be new or unfamiliar to them. And I think the idea that the federal government intervenes without risk capital so that then the rest of the regular machine can take over is a brilliant idea.
00:46:19:11 - 00:46:26:18
Hector Negroni
And there was a good bit of that. And it's focused a little bit towards broadband and some discussion of EVA, but it's probably not nearly enough.
00:46:26:29 - 00:46:27:27
Mark Paris
Price to pump, though.
00:46:28:17 - 00:46:48:26
Hector Negroni
Yeah, it it's nice and I it'll create interesting opportunities around smaller deals and private deals that we tend to focus on. But I don't think it's necessarily a scalable solution. And you're right, generally the market works. I just my key is it's all about the diverse. We don't need equity capital in the marketplace. We need we need diverse credit capital.
00:46:48:26 - 00:47:05:28
Hector Negroni
The capital stack in our marketplace is pretty levered. We can lever the equity pretty well in our space. The equity being kind of the government ownership, it's pretty easy to lever that pretty well. But when you're levering it to just one audience, which is just retail taxes and buyers oversimplify, I think that's shortsighted.
00:47:08:02 - 00:47:29:28
Lynne Funk
More kind of on time or just off. Are there any questions in the audience going, what's going? What would you guys like to leave us with? So everybody in this room, I know there's eagerly awaiting a cocktail. What what's the big takeaway with the rest of 20, 22? I mean, it's most depressing.
00:47:31:01 - 00:47:37:02
Hector Negroni
The bars out back I think I think folks be concerned about liquidity. It's really my focus.
00:47:37:08 - 00:47:38:04
Lynne Funk
Liquidity. I'm good.
00:47:38:11 - 00:47:42:20
Sylvia Yeh
Yeah. Don't do it on your own. Definitely leverage the expertise of professional management.
00:47:43:07 - 00:47:44:23
Mark Paris
Yeah. I was going to say active management has.
00:47:45:23 - 00:47:52:24
Lynne Funk
Active active management and professional management. Okay. Well, thank you to the panel so much. Great discussion.
The Buy-side Take: What an Evolving Muni Landscape Means for Investors
April 7, 2022 11:10 AM
48:00