Muni managers take sides in the Puerto Rico debate, address the bond landscape in Chicago, Detroit, and California, and discuss the advantages of CEFs in the muni space.
Last week, Morningstar hosted the 26th annual Morningstar Investment Conference. During the conference, attendees heard keynotes from some of the industry's highest-profile fund managers, including Franklin Templeton's Michael Hasenstab, PIMCO's Bill Gross, and AQR's Cliff Asness. While these speakers didn't disappoint, several of the most interesting and engaging conversations happened between keynotes in more intimate panel discussions. On June 20, I moderated a panel with three prominent municipal bond managers to discuss the current market, where they see opportunities, and why closed-end funds can be great vehicles for municipal bonds.
The panelists included John Miller, co-head of fixed income and head of munis at Nuveen Investment, Rob Amadeo, head of municipals at Western Asset Management, and Joe Deane, head of municipal bonds at PIMCO. These three managers run billions of dollars in municipal bond assets and have decades of experience in the asset class. Each runs both open-end and closed-end municipal bond funds.
Puerto Rico: The Great Divide
The hottest topic of the day was Puerto Rico. Deane wasn't shy about his negative view of the territory. He noted that it is the third largest-municipal issuer, behind California and New York, but it's a "small island in the Caribbean" with a tiny population relative to other large issuers. He pointed to a "brain drain" on the island as a major stumbling block to any recovery. Because Puerto Ricans are citizens of the United States, many highly educated residents have left for places like Miami and New York City because of better job opportunities. PIMCO no longer holds any Puerto Rico bonds.
Though Amadeo admitted that Puerto Rico has its problems, he believes COFINA bonds (sales-tax-backed bonds) are worth holding. According to Amadeo, those bonds bring in $1.3 billion in revenue to cover $700 million in debt service. In the past, government corruption meant that a good portion of tax revenue went missing, but Amadeo pointed to new measures put in place that he believes will make it more difficult for politicians to divert the revenue.
Miller agreed with Deane that Puerto Rico had high hurdles to overcome and noted that after issuing nearly $4 billion in bonds just a few months ago, the territory is once again facing liquidity issues. Miller, however, agreed with Amadeo that COFINA bonds were the best to own on the island, and, as of May 30, some of his portfolios held those bonds.
Chicago, Detroit, and California
After a lively debate over Puerto Rico, the panelists were largely in agreement over the situations in Chicago, Detroit, and California. Miller, who lives and works in Chicago, believes that while it has big problems with its pension liabilities, the city can still right its course. In his opinion, the city has two options to deal with the unfunded (and constitutionally guaranteed) pensions: raise taxes or cut pension benefits. He says Chicago mayor Rahm Emanuel is hesitant to take either path and has, so far, pushed back on the governor of Illinois for reforms at the state level. As for his investments, Miller likes general-obligation bonds backed by Assured Guaranty and bonds issued by the Chicago Transit Authority.
Turning to Detroit, Amadeo noted a "reranking of risk" regarding the city's general-obligation and revenue bonds. Historically, general-obligation bonds have been considered safer than revenue bonds and have been priced to reflect that relative safety. The Detroit bankruptcy has challenged that assumption. The city's revenue bonds (specifically, water and sewer bonds) are in better shape than its general-obligation bonds, the holders of which are likely to receive less than full value for those bonds. Amadeo does hold water and sewer revenue bonds from Detroit in his portfolios.
Finally, Deane pointed to California as a success story in the muni market. A few years ago the state was facing massive budget issues, but fiscal belt-tightening stopped the bleeding, leaving the state's finances in much better shape. He believes those actions provide a blueprint for other cities and states in similar situations.