As I have noted in earlier posts, the performance of the municipal asset class has been better than anticipated thus far this year. Investment grade municipal bonds, as measured by the Barclays Municipal Bond Index, as of yesterday have now generated positive returns of 9.3% while the Barclays Municipal Bond High Yield Index is up 12.2% for the same time period. In prior posts I have outlined some of the fundamentals leading to these results and I have also pointed to the relationship between muni high yield and corporate high yield as a factor that may have attracted significant assets to the asset class.
The yield ratio of muni high yield to corporate high yield has been over 100% for the past 14 months. In the nearly 20-year history of the Barclays indices, this ratio, or relative value, of muni high yield has never before reached these heights. The huge rally in corporate high yield, i.e., the move to lower yielding bonds, and the surge in size of the muni high yield sector, with the addition of Puerto Rico credits, are responsible, in part. Now, as investors have taken note, the ratio of muni high yield to corporate high yield has come in from a high on June 30th of 136% to approximately 106% on September 30th as increased demand and spread narrowing have begun to move the indices in the direction of reversion to the mean, or to a more normalized relationship. The good news for municipal bond investors is if the long-term average is representative of “normalized,” we still have a way to go before the ratios reach 76%.
Yield Ratio of Barclays High Yield Municipal Bond Index to
Barclays Corporate High Yield Index
September 2003 – September 2014
Source: FactSet as of September 30, 2014.
Spread tightening is generally one natural consequence of demand and has typically generated the type of performance we’ve seen in the muni market this year. The example above illustrates that high yield corporates are still not yielding as much as high yield municipals, although the difference between their yields is narrower than it was mid-summer. However, with ratios remaining above 100%, I believe high-yield municipal bonds may continue to attract a wide variety of investors looking for income and value potential through the final quarter of 2014.
Yield ratio is the ratio of the yields between two indices or bonds. The equation is: Yield Ratio = Yield of Index A / Yield of Index B.
Yield to worst measures the lowest of either yield-to-maturity or yield-to-call date on every possible call date.
Spread tightening is when the difference in yield between two indices or bonds becomes less pronounced.
The Barclays Municipal Bond Index covers investment-grade municipal bonds with a nominal maturity of one or more years. The Barclays High Yield Municipal Bond Index covers below investment-grade municipal bonds with a nominal maturity of one or more years. The Barclays Corporate High Yield Index covers 50 of the most liquid and tradable U.S. dollar-denominated, non-investment grade corporate bonds for sale in the U.S.