We already own quite a bit of preferred shares issued by Annaly Capital Management (NLY), but I'm re...
A Muni Fund for Preservation and Income
12/19/2011 10:10 am EST
Though there were some dire predictions about municipalities several months back, the muni bond market remains healthy, says fund manager Steven Shachat. He tells MoneyShow.com about his investment process, and why he’s bullish on fixed income.
Some investors have become scared of munis or shied away from fixed income recently. So Steven, tell us, how should investors view your fund vs. an equity fund?
Steven Shachat: First of all, on a global level, we are very comfortable with the municipal bond market and have been for some time.
Do we think we are getting compensated to take on the risk that we are taking, relative to the low interest environment? Perhaps not, but do we look at this market in some type of catastrophic terms? Absolutely not at all.
Now, our fund is a little unique in nature, in the fact that its focus is primarily on preservation of capital and maximizing income, and it’s a very short duration in nature. It has got an average maturity of 68 days, and a duration of .17.
As I said, the two primary objectives are to maximize the income and to minimize NAV fluctuation. And we do that by trying to take advantage of all of the aberrations and inefficiencies of the municipal marketplace that we can find. Most importantly, we manage this fund, vs. maintaining it like some of our competitors do.
Kate Stalter: So given that, how do you make decisions when to get in and out of a particular instrument, then?
Steven Shachat: Well, we sort of take a different approach to the market in the respect that we are looking for those needles in the haystack.
So it’s not particularly that we like one sector of the market geographically, or we like one sector of the market from an industry perspective, vs. this one type of individual security looks really attractive for specific reasons; i.e. it might be being called three weeks from today and it is producing an extraordinarily high yield. Or maybe it was a security that we were fortunate to buy on a Friday afternoon at three o’clock when nobody else was out there.
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So we kind of look at the whole market, and then try to find individual securities that can meet our objective, which is, as I said, trying to generate as much income as we can, but where we know the downside risk is minimal, if at all.
This is a little bit different than the way that other funds are run, which is, they stick to a specific maturity guideline or perhaps industry guideline, and they say this is kind of where we have to be all the time.
The way our portfolio looks today could be completely different three weeks from today, three months from today, or a year from today. That is what I think makes our portfolio so unique vs. what our competitors are doing.
Kate Stalter: Given the fact that some of these holdings could be kind of transient as you describe it there, what are some of the names you are holding now, and why did you choose to buy these?
Steven Shachat: Well, our biggest holding right now is a variable-rate demand obligation issued by the State of Illinois. In fact, our biggest sector of holdings, by types of securities, are variable-rate demand notes, and they have been a really attractive offering for our fund for two key reasons: They have been very attractively priced, and they provide the fund with a lot of liquidity and no NAV fluctuation.
Now, this is a sector of the market that just happens to be out of sync a little bit with the rest of the marketplace, and the primary reason for that is because the largest holders of these securities are money market funds. Because of the turmoil of what has happened in the money market fund industry over the past three years, it has created a really attractive buying opportunity for us to take advantage of this.
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If we go back four years ago, our holdings of these types of securities were minimal, because they were not attractive in yield, from our perspective, relative to other types of securities that we could buy. And it is only now that they have become very attractive, that they become a larger component of the portfolio.
Other names we have that fall into that variable-rate demand note category also include the New Jersey Turnpike Authority...We have some Wisconsin Health and Ed authority, same type of thing. Michigan State Housing—all variable-rate demand notes.
When that pool of securities dries up and they become less attractive, we will move on to the next needle in the haystack that we can find.
Kate Stalter: Anything else other than the variable-rate demand category that might be worth a mention at this point?
Steven Shachat: Well, we look at all different sectors of the muni market, whether it is regular municipal bonds like we are all familiar with...they have a stated maturity and they pay interest every six months.
We also look at tax-exempt commercial paper, where once again we have been able to find some specific opportunities where they have been very attractively priced. Tax-exempt put bonds are types of municipal bonds that have a long stated maturity, but give the holder the right to sell the bond back to the issuer on a three-month, six-month, one-year, two-year, three-year, whatever basis.
We also look at general market notes. Those have been a fairly attractive group of securities for us lately. Those are just cash flow notes that are issued by states and municipalities to shore up their finances for a certain period of time.
So getting back to what I originally said, we kind of look in any of those sectors where we can find specific value, and there is no real hardcore rule about how any one of those are priced vs. the other ones.
The beauty behind the municipal marketplace is, it’s highly inefficient, and it is not like buying stocks, where you are going to pay the same price in New York as you do in California. It is our job to try to take advantages of these inefficiencies and to try to find where certain securities are trading out of sync with other securities of comparable quality.
- Also read: 3 Simple Rules to Buying Munis
Kate Stalter: A few months ago, a lot of investors got frightened about municipals because analyst Meredith Whitney made a call forecasting that many of these municipalities would go bankrupt. How should investors view that kind of information in light of what you are saying today?
Steven Shachat: Well, I think they should view it with the same credibility that they viewed Donald Trump as running for president of the United States.
The fact is this woman has no credibility in the municipal bond marketplace. She has basically been a bank analyst. She has gone out on her own as a stock analyst and has produced mediocre results at best, and what better way to reinvent yourself then to go on “60 Minutes” and start predicting the demise of the municipal bond marketplace.
If you really analyze the history of the municipal bond marketplace, it has an exorbitantly low default level. In fact, in 2011 the default rate on municipal securities was less than in 2010, and 2010 was an abnormally low year.
The one positive that has actually come out of this is that the states and municipalities have really started to tighten their belt as far as the issuance of debt and how they are spending money, and so hopefully that is a good thing going forward, and I wish our Federal Government would follow suit.
The bottom line is: We do not see anything on the horizon that makes us want to steer away from this class of securities. Are there going to be specific situations? Absolutely, we just saw it done in Jefferson, Alabama. We saw it in Harrisburg, Pennsylvania.
You also have to understand that these are two situations that have been on people’s radar screen for the last three years, so it is really nothing new to people that are in the marketplace on a day-to-day basis.
- Also read: No Excuse to Keep Rule-Breaking Munis
Kate Stalter: Let me wrap up with one last question for you today, Steven. How should a fixed-income fund be balanced with equity holdings in an overall investment portfolio?
Steven Shachat: Well you know, I guess that depends upon each specific person’s objective in how they want their money to work for them. Obviously as I stated, the objective of this fund is to maximize interest and to minimize NAV fluctuation. This is not a total-return type of fund, and if you are looking for that type of boost from your investment, this is not going to be the best alternative for you.
But I think, based upon how the market has been trading lately and how the equity markets have been trading, that people are finding that having a larger component of fixed-income securities, i.e. tax-exempt securities, especially if you are in a higher tax bracket, has proven to be a very rewarding experience over the last several years. And we don’t anticipate that reallocation changing any time soon.
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