July 23, 2018: Municipal Bond Funds And Portfolios

Jul 25, 2018 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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For regular SAA and TAA portfolios, the next re-balance will be on Monday, August 20, 2018. You can also find the re-balance calendar for 2017 on ‘Dashboard‘ page once you log in.

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Please note that we now list the next re-balance date on every portfolio page.

Municipal Bond Funds And Portfolios

MyPlanIQ maintains brokerage specific municipal bond fund portfolios. We regularly reviewed these portfolios. In April 16, 2018: Municipal Bonds As A Fixed Income Asset Class, we argued that these investments by themselves should be treated as an asset class in a portfolio, regardless of tax consideration. 

In this newsletter, we will look at municipal bond funds in some details. First, let’s look at the performance. 

Positive returns of the municipal bond portfolios

In current rising rate environment, many taxable bonds have had negative YTD  (year to date) returns. Not the municipal bond portfolios listed on What We Do -> Brokerage Investors page: 

Portfolio Performance Comparison (as of 7/23/2018):
Ticker/Portfolio Name YTD
Return**		 1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
Fidelity Muni Bond Funds 1.3% 5.8% 5.2% 5.6% 6.6% 1.92
Schwab Muni Bond Funds 1.3% 5.8% 5.2% 5.6% 6.6% 1.92
Merrill Edge Muni Bond Funds 1.0% 3.3% 3.8% 4.3% 5.8% 2.14
Etrade Muni Bond Funds 1.0% 3.3% 3.8% 4.3% 5.8% 2.15
Vanguard Muni Bond Funds 0.4% 3.1% 2.9% 3.3% 4.5% 1.75
VWIUX (Vanguard Interm-Term Tx-Ex Adm) 0.0% 0.9% 2.6% 3.3% 3.9% 1.37
VBMFX (Vanguard Total Bond Market Index Inv) -1.9% -1.1% 1.5% 1.9% 3.6% 0.89

10 year charts: 

Year to date, these portfolios have now had positive returns, unlike in April when we last reviewed them. 

More importantly, these portfolios and Vanguard intermediate term tax exempt bond fund VWIUX have done better for the last 1, 3, 5 and 10 year periods than the taxable bond fund VBMFX, even in absolute returns before considering tax benefit. In absolute returns, these portfolios also have done better than their taxable total return bond fund counterparts for the past 1, 3 and 5 years. On the other hand, they have mostly underperformed against taxable ones for the past 10 years. We suspect that once tax benefits are taken into account, they are probably in par for the 10 year returns.  Interested readers can look at these on What We Do -> Brokerage Investors page.

Municipal bond funds

Readers might have noted that among these brokerage specific portfolios, some of them are doing better than others. For example, Fidelity Muni Bond Funds are better than Vanguard Muni Bond Funds by some big margins. We attribute this discrepancy to the performance difference between Nuveen municipal bond funds and other funds. Unfortunately, not all of the main brokerages have Nuveen bond funds available as NTF (No Transaction Fee) no load funds. We have to resort to other funds in those brokerages. 

Of course, Nuveen asset management company is a well known municipal bond investment powerhouse. They have some of the best municipal bond funds.  Their concentrated municipal bond staff includes 25 municipal credit analysts, five risk analysts, and 12 traders. 

The following table compares Nuveen candidate funds and Vanguard muni bond funds used in our muni bond fund portfolios: 

Muni Bond Fund Performance Comparison (as of 7/23/2018):
Fund YTD
Return**		 1Yr AR 3Yr AR 5Yr AR 10Yr AR 10Yr Sharpe
NHMAX (Nuveen High Yield Municipal Bond A) 1.7% 6.2% 6.4% 7.7% 5.5% 0.93
VWAHX (Vanguard High-Yield Tax-Exempt) 0.4% 3.1% 4.3% 5.1% 5.2% 1.46
FLAAX (Nuveen All-American Municipal Bond A) 0.3% 3.0% 4.0% 5.2% 5.5% 0.66
VWLUX (Vanguard Long-Term Tax-Exempt Adm) -0.2% 1.9% 3.6% 4.7% 4.7% 1.33
NMBAX (Nuveen Interm Duration Muni Bond A) 0.5% 2.0% 2.9% 3.4% 3.8% 1.4
VWIUX (Vanguard Interm-Term Tx-Ex Adm) 0.0% 0.9% 2.6% 3.3% 3.9% 1.37
FSHAX (Nuveen Short Term Municipal Bond A) 0.9% 0.7% 0.8% 0.9% 1.7% 1.14
VWSUX (Vanguard Short-Term Tx-Ex Adm) 0.9% 0.9% 0.9% 0.8% 1.3% 1.7

One can see that Nuveen funds have been very strong compared with their Vanguard counterparts for the most of past 10 years. 

But we also note that for the past 10 years, Nuveen funds have exhibited higher volatility than Vanguard funds. For example, even though FLAAX returned better than VWIUX in the past 10 years, it actually had lower Sharpe ratio, indicating it has higher fluctuation (or volatility). Basically, in the same category, Nuveen funds have adopted riskier bets in terms of duration, credit quality and even leverage. 

We can further look at NHMAX (Nuveen High Yield Municipal Bond A).  Based on Morningstar,  it currently has about 77% invested in junk-rated (lower than BBB) muni bonds. Furthermore, this fund can take on up to 30% leverage. This approach didn’t serve it well in 2008: it lost over 40% compared with Vanguard VWAHX’s 10%! One can say that Nuveen muni bond funds are the Loomis Sayles bond funds in the muni bond world: both of the funds are willing to take extra risk to boost returns. 

It turns out that having Nuveen bond funds as candidate funds in our municipal bond fund portfolios can help to increase returns without incurring much more risk. This is because in our portfolios, when candidate bond funds have exhibited a negative trend, these portfolios will switch to those that still exhibit a positive trend or at worst, they will switch to cash temporarily to wait out the downturn. For example, Fidelity muni bond fund portfolio returned -0.5% in 2008, compared with VWIUX’s -0.1% or VWAHX’s -10%!

In conclusion, Nuveen muni bond funds, though riskier than their peers, can be good candidate funds for a tactical fund rotation portfolio like our muni bond fund portfolios. However, it’s not really advisable to just buy and hold these funds, in our opinion. 

Municipal bond market review

Finally, we want to briefly review muni bond markets. A generally agreeable observation is that demand has outstripped supply in the municipal bond market. The tight supply is due to the tax reform (which eliminated the exemption for advanced refunding bonds, a type of tax exempt bonds). In fact, the issuance has been down 19% year to date (end of June) vs. the same period last year. On the other hand, demand from reinvestment from matured bonds and other sources has been very strong. This results in higher bond prices, even amid a rising interest rate environment. 

However, in such a rising rate environment, we remain cautious on a buy and hold approach in muni bond investing. We believe a dynamic bond fund rotation approach is much better suited. 

Market Overview

It’s earnings report season again. By last Friday, based on Factset, 17% of S&P 500 companies had reported earnings for Q2, 2018. So far so good: the blended earnings (actual and expected) growth is 20.8%, better than the 20% expected on 6/30/2018. If the expected earnings growth rate can be met, it would mark the highest earnings growth since Q3, 2010. Basically tax reform and the strong economy have indeed driven higher corporate earnings growth. 

On the other hand, stock prices remain at elevated levels and the aggregate valuation is historically high. As always, we call for staying the course.  

For more detailed asset trend scores, please refer to 360° Market Overview. 

Now that the Trump administration has been in the office for more than a year, the economy and financial markets are in general still in a good shape. Whether the economy will continue to benefit from the supposedly trickle down of the tax cut, the deregulation, and the promised infrastructure spending remains to be seen.  On the other hand, stocks continued to ascend, regardless of the progress. Looking ahead, however, we remain convinced that markets will experience more volatilities at some point when reality finally sets in. 

In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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