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Not the Time for Home Runs in Muni Market

Miriam Sjoblom, CFA

Miriam Sjoblom: Hi. I'm Miriam Sjoblom, associate director of fund analysis at Morningstar. And I am here today with veteran muni manager Joe Deane, who surprised the mutual fund industry this summer when he joined PIMCO to lead up PIMCO's municipal bond portfolio management.

So, thanks for taking the time to meet with us today, Joe.

Joe Deane: I appreciate the opportunity, believe me.

Sjoblom: Just kind of looking back at your career, before you joined PIMCO this summer, you had a very long career, most recently at Western Asset, but before that you were with Citigroup Asset Management and Smith Barney. And you've managed the Legg Mason Western Asset Managed Municipals since 1988. So you've had this very long career at that fund, and this seems like a pretty significant change for you (at PIMCO). I think our viewers will be interested in hearing what made this opportunity at PIMCO so compelling.

Deane: Well, when you make a change like this at this stage of your career, there's always a reason why you leave; there's always a reason why you go. And I think for me the most compelling part of this is that you could really boil it down into a four letter word: Bill (Gross). I mean I've competed against Bill for a lot of years. I think he's the greatest fixed-income manager that ever picked up a telephone, and the fact is that his career was really built on total return. I've really built my career in the municipal business on total return, and I think it's just a much, much more natural fit than at any point in time in my career probably since I worked at E.F. Hutton back in the early '80s. I think it's a very, very natural fit for both me as well as for PIMCO.

Sjoblom: Well, as you mentioned Bill Gross and PIMCO are very well known for forming these macroeconomic views, and sometimes these views get implemented across portfolios. I think in your own management style, you've definitely had some very pronounced views at times, and those will be reflected in the portfolio's performance looking very different from the market's. Do you anticipate having to adjust your style at all to kind of fit in to this macroeconomic view that PIMCO has?

Deane: Well, I think that no matter where you work, Miriam, over your career, there are always going to be some sort of goalposts that have to be established. You don't want to be a rogue; you don't want to be out on a limb. I've never been that in my career, but what I want to be able to do is really help them build a business that will reflect the feelings of the investment committee, but I want to be able to adjust those to a certain degree to the realities that we actually see in the municipal business, which sometimes can be very, very different than what's going on in taxables.

Sjoblom: What would be example of that?

Deane:  A classic example would have been earlier this year when the market was under a lot of duress because of Meredith Whitney's comments that haven't born fruit yet and never will. The taxable markets were doing great. They were going up, and we were getting absolutely crushed at the same time. That would have been the time where maybe on this taxable side of the world you wanted to be a little bit more conservative, and a little bit more laid back. And in the municipal market you wanted to buy everything that wasn't nailed to the floor.

That happens from time to time, I would say especially since post 2008. I think that was a watershed event. I think up until 2008, we had a municipal market that, I would use the term, was a little bit more Treasury-centric, in that it was a little bit percentage over Treasuries or a little under. But I think with the destruction of the single-strategy hedge fund, with the destruction of all of the insurers of municipal bonds basically, they really turned into more of a spread product, and I think the trading characteristics of our market today are really remarkably different than what they would have been say from like the early '90s right up until the end of '07.

Sjoblom: Mentioning this transition in the market, becoming less of the rates market and more of a spread or credit market, PIMCO certainly is well-known for its resources on the taxable side. It's muni business has until now have been a lot smaller; some of the taxable analysts also do municipal credit work. What kind of plans do you have for building out the municipal team? Do you feel like you have the resources you need in place already or are there plans that you have for kind of bolstering the resources?

Deane: Well, it's really two sides of the coin. Number one, I think from a money management standpoint, at least at the size that we are today, we have sufficient portfolio managers. Julie Callahan came over from Western with me, and we have Vic Kalaydjian, who works with us who was there previously.

But on the research side when I was talking to the folks before I came over, I told them they just had an inadequate research staff. I mean they only had two people. Both were very bright guys, but it was still only two people. And I told them that they needed a total of five. The day I walked in they already had four; they had picked up two quality analysts. And we'll probably be looking for that fifth person during the course of the next couple of months, and it should be a relatively senior person. You need that many people because it's not just looking at new-issue credits; once you own it, your job really begins. So you have to have follow-on work. You have to get the six months audited numbers and make sure that what you bought in the first place is still true today. That's why you need the staff.

Sjoblom: You mentioned the opportunities had been different in the municipal market beginning this year versus the taxable market. If we were to look at the two portfolios--your managed municipals fund from your previous charge plus the new PIMCO Municipal Bond one that you're running now--those funds are competitors. But starting off when you made this transition, their positioning was very different. The PIMCO fund was more focused on intermediate maturities, and your Legg Mason Western Asset Fund was more on long maturities and general obligation bonds, for example. You haven't really liked general obligation bonds for several years now, thinking they're somewhat overpriced. Can you talk a bit about the transition coming into PIMCO and dealing with portfolios, looking the way they are?  What's the process like to get them looking the way you want them to?

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Deane: Well, I think the first assessment that you have to make is do you like the market; do you not like the market; is the market cheap as dirt; is the market relatively high? This is because that's going to color what you're going to do in the immediate future. I mean if I came in here six months ago and you were going through the Meredith Whitney extravaganza, we would have been very, very aggressive at buying somewhat longer paper, changing the asset mix that we had because I thought it was an unbelievable buying opportunity.

I think one of the things that held back the PIMCO funds over the years is that they have just been too short. They were too far in the curve; they were very high-grade. They did have a reasonable number of GOs. I just don't think it was the right mix for the marketplace that you've had during the last three to five years. That's why they underperformed their benchmark and a lot of portfolios including me.

I think what you're seeing here right now though you've had a pretty tremendous rally. People finally realized that what was being talked about was simply not going to come to pass. So, you've had a stupendous rally in the last two to three months. You're at levels right now that are approaching the highs that we hit over a year ago. I think for right now, I kind of like the fact that we are a little shorter, that we're a little high grade, and that we're not in anywhere near as risky a position as probably most of our peers right now. I think for this point in time in the marketplace, that's where I would definitely want to be. In fact even if I were back at the old fund, which you know was my baby for the many, many years, I'd be pretty aggressively selling long paper right now because I think you're approaching a peak in here.

Sjoblom: Maybe this is good transition into what you think investors can expect from the muni market. It seems we have already had all these outflows when Meredith Whitney's report came out on 60 Minutes, and even just the losses alone seem to spook investors. And now we're at this point where yields once again are at all-time lows. What do you think investors can expect from the market in the rest of the year?

Deane: Well I think this, number one, munis at least on a relative-value basis are still a lot cheaper than Treasuries and a lot cheaper than corporates. And even on a credit-for-credit basis, they are cheaper than high yield too, on an aftertax basis. So, it's a product that you want to own, but I think if you're going to use a baseball adage right now, it's a time in the marketplace to try and hit singles and doubles. There's a time when you want to hit it out of the park. And I've hit it out of the park a lot of times, you know that. But this is not when you want to try and do that.

What you're trying to do right now is keep it a little bit shorter, keep it a little defensive. I think in a long run, if you take a look at my career, or just the way I believe that markets work, I mean if you win the down markets and you're pretty competitive in the up markets, you kill everybody. This is because the speed of a down market is probably 5 times the speed of an up market, and if you really get killed in a bad downturn, it takes you years to make that back up. If you can protect your clients--and I think it's one of the most important things as we do as money managers--it really stands you in very, very good stead over a relatively long period of time, and it's always been the pattern that I have had.

Sjoblom: Well, Joe, thank you for being with us today and sharing your insights.

Deane: Thank you. My pleasure.