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A Portfolio Strategy That Will Give Your Bonds A “Kick”

For many fixed income investors, today’s interest rate environment often seems like the old complaint about the popular restaurant- Nobody goes there anymore-because it is so crowded.

Just like getting a table in a crowded restaurant, interest rates for the individual investor are the product of supply and demand. For municipal bond investors both of those factors have headed in the direction of lower interest rates.

From the supply side, according to Thompson Reuters, new issue supply has declined 25% year-over-year. In 2013 the weekly issuance of new municipal debt averaged approximately $5.5 billion. This year the average is about $4.8 billion. Looking ahead, it’s not all bad news from the suppliers of debt. The Bloomberg 30 day visible municipal supply as of June 16 is $8.4 billion, slightly above the 12 month average of $8 billion.

For many conservative investors the supply problem is exacerbated because, according to data tracked by Thomson Reuters, Baa1 through A3 rated bonds are the only credit sectors with increased supply as issuers have taken advantage of tight credit spreads caused by investors reaching for yields. This increased supply in the lower end of investment grade bonds has meant an even greater percentage decline in supply for higher rated bonds-A through Aaa.

The following chart shows the yield difference between AAA rated municipal bonds and other rated bonds in various maturity ranges.

On the demand side, according to Lipper FMI, municipal bond funds have experienced net inflows- more investors buying bond funds than redeeming-18 out of 24 weeks this year.

So supply is down and demand is up. How can an individual investor seeking to increase tax free income develop a portfolio strategy that makes sense in today’s market?

Increasing interest rates following a low interest rate environment will pose a significant risk to an investor’s portfolio. Since bond values fluctuate inversely to changes in interest rates, a rise in general market interest rates will cause the value of your portfolio to decline. To mitigate this risk many successful investors seek the protection of a higher than market rate coupon available from a premium bond. This type of bond, priced above 100, will have a lower relative duration than par or discount bonds of the same maturity.

Duration is a measure of interest rate sensitivity based on the maturity of a bond and its coupon rate. Premium bonds because of their high coupon rates, will have a duration shorter than their maturity, meaning a lower sensitivity to interest rate changes. Premium bonds with a call option are priced as if the call date was the maturity date. With the stated yield to maturity higher than the yield to the call, investors will receive a higher rate of return if their bonds are not called at the first scheduled call date. This situation becomes very attractive in a rising interest rate environment. This “kick” in return may mean a rate of return better than anything else in today’s market.

Trader’s Analysis

Our Trader’s Analysis charts the year over year spread in the yield curve for AAA rated General Obligation Municipal bonds.

Source: Source: Thomson The Municipal Market Monitor (TM3) MMD Long-Term Strategy Report, May 2014. Past Performance is not an indication of future results.

Why Hennion & Walsh

We are specialists in tax-free municipal bonds.

Tax-free municipal bonds are Hennion & Walsh’s heritage – it’s who we are. When we founded Hennion & Walsh over 24 years ago, we started out as specialists in tax-free municipal bonds. We built our reputation by selling high quality municipal bonds to individual investors looking for potentially safe, predictable income that’s tax-free. Although we are a full-service brokerage firm today, including portfolio management services, our clients still enjoy the value of our expertise finding municipal bonds for their investment needs. We also still deliver the same one-onone personalized service we’ve provided since our founding in 1990.

Unlike some competitors, we offer individual investors direct access to municipal bonds in the primary and secondary markets. Bonds are a dynamic investment. While some of our clients are looking to buy and hold, others are interested in frequent trading opportunities. We provide the investment opportunities that each client is looking for with a full service municipal bond trading desk, current market information, and investing opinions designed to enable clients to make the right decisions.

Because of our active municipal bond trading desk we are able to identify and purchase blocks of attractive municipal bonds when they become available in the primary and secondary markets. In addition, Hennion & Walsh aims to offer investors the highest standards of professional conduct for their accounts.

Personalized service isn’t just a slogan at Hennion & Walsh. It’s how we do business.

It’s no wonder that many people turn to professionals for help, guidance, and advice when it comes to their investments. The question is to whom they should give this responsibility.

At Hennion & Walsh, we believe that the management of wealth should be taken as personally as its accumulation. We recognize the commitment our clients have made to building and maintaining their investments. Knowing this, how could we not manage and protect those investments as carefully – and as personally – as we can?

More than 15,000 clients call upon us for our advice and expertise. We deliver one-on-one attention that enables us to truly understand our clients’ needs and work in close partnership with them, regardless of account size. We do not have a call center or voicemail – we personally answer each call our clients make. We have built our firm’s reputation on developing strong, mutually beneficial relationships designed to last a lifetime.