Speaker 1: Welcome to Inside Active, a podcast about active managers that
Speaker 1: goes beyond sound bites and headlines and looks deeper into
Speaker 1: their processes, challenges and philosophies and security selection. I'm David Cohne,
Speaker 1: I lead mutual fund and active Research at Bloomberg Intelligence.
Speaker 1: Today we're going to be discussing munis and the advantages
Speaker 1: that active management can provide. Little context. First, active municipal
Speaker 1: mutual funds actually took in over twenty four billion in
Speaker 1: inflows last year, and as we all know, mutual funds
Speaker 1: are the less preferable wrapper right now, so you definitely
Speaker 1: know this interest and active munifunds. And I will also
Speaker 1: say that active muni ETFs also took in nearly twenty
Speaker 1: two billion last year. And so for this discussion to
Speaker 1: discuss munis, we're happy to have Alex Patron on with us.
Speaker 1: Is managing director and head of fixed Income and head
Speaker 1: of distribution for the Americas for Rockefeller Asset Management. Alex,
Speaker 1: thank you for joining me today.
Speaker 2: David, thank you, it's great to be here.
Speaker 1: So you spent your career in fixed income across multiple
Speaker 1: market cycles. What do you think feels fundamentally different about
Speaker 1: today's environment compared with past periods.
Speaker 2: Well, I think you.
Speaker 3: Know a couple of features that make this cycle distincts.
Speaker 3: First of all, we've transitioned from this really long period
Speaker 3: of zero and negative policy rights to a world where
Speaker 3: the yield curve is steep, The municipal yield curve is
Speaker 3: tremendously steep, and there's really compelling opportunities for investors today
Speaker 3: within fixed income, and it resets in our view, both
Speaker 3: returns across the curve.
Speaker 2: And it improves fixed income's role.
Speaker 3: Both as income and a ballast within portfolios. And I
Speaker 3: would say secondly, the macroeconomic environment mint is unique today
Speaker 3: and dispersion is elevated. You've seen inflation moderating a bit
Speaker 3: from its peak, but it remains stickier in spots. You've
Speaker 3: seen growth that's remain and proven quite resilient. But there
Speaker 3: are going to be clear winners and losers, whether you
Speaker 3: look at the equity markets, the bond market, and very
Speaker 3: specifically within municipals. So for our view for investors, this
Speaker 3: really argues in the environment that we're in today, sell
Speaker 3: activity over beta and investors really will continue to benefit
Speaker 3: from active management where you are getting paid in many
Speaker 3: respects to do the bottom up credit research and identify
Speaker 3: opportunities where there might be idiosyncratic spread drivers or other
Speaker 3: factors that can really drive returns from here.
Speaker 1: So glad you mentioned that with active, because you know,
Speaker 1: Active obviously made a comeback, especially on the equity side
Speaker 1: the last couple of years. And you know, I think
Speaker 1: active was underwhelming to a lot of retail folks for
Speaker 1: a while. Well you know, they just they looked at
Speaker 1: index funds and the you know, very very cheap. You know,
Speaker 1: there seemed to be this kind of sentiment that passive
Speaker 1: was the way to go, even in fixed income. And
Speaker 1: you know, passive can look efficient on the surface, but
Speaker 1: where do you think the gaps really are with you know,
Speaker 1: where active management can add value, especially in fixed income.
Speaker 3: You know, David a great question, and you see it
Speaker 3: tremendously within the municipal market. More specifically, if you look
Speaker 3: at twenty twenty and eighty five, it was a really
Speaker 3: interesting year in which you saw investment grade municipal indicices
Speaker 3: outperform high yield municipal indices. Now, what makes that interesting
Speaker 3: and unique is in most environments, your fixed income or
Speaker 3: your income is a key part of your total return.
Speaker 3: If you look at the higher yield municipal indices, the
Speaker 3: yields were in the five and a half percent range
Speaker 3: tax exempt really compelling. If you look at high grades,
Speaker 3: the yields are closer at about four percent over the
Speaker 3: course of the year tax exempts. So inherent your setup
Speaker 3: should have been that the high yield media indicies outperform.
Speaker 3: But what we saw in twenty twenty five is there
Speaker 3: is a handful of issuers and sectors really tobaccos and
Speaker 3: then from an issue perspective, transportation and bright line that
Speaker 3: really drove down returns within the high yield market. For
Speaker 3: those investors that focus on passive indices. There's a structural
Speaker 3: inefficiency there. You might be over allocated to these areas
Speaker 3: just because they tend to be larger components of the
Speaker 3: benchmark that are issuance weighted, not necessarily quality or relative
Speaker 3: value weighted.
Speaker 2: You can you can dive in even further to that.
Speaker 3: David, and look at dispersion amongst managers, particularly in markets
Speaker 3: like the municipal market or the corporate bond market, where
Speaker 3: you have a tremendous amount of diversification opportunities that if
Speaker 3: you are active and avoiding some of the pitfalls of
Speaker 3: either bench are hugging or following the benchmark, you might
Speaker 3: see a material difference in what performance looked like over
Speaker 3: the course of twenty twenty five. And that's really apparent
Speaker 3: in some of these markets where there are inefficiencies, a
Speaker 3: lot of opportunities, and bottom up credit fundamentals really matter materially.
Speaker 1: I'm glad you brought that up, especially with dispersion and
Speaker 1: this credit dispersion and we have uncertainty with interest rates.
Speaker 1: How do you think that's really changing the calculus for
Speaker 1: active bond managers?
Speaker 4: You know right now in today's environment, you.
Speaker 3: Know, when you have the amount of interest rate volatility
Speaker 3: and uncertainty that we've had over the course of the
Speaker 3: last really several years now, it is really important to
Speaker 3: think through how can I build portfolios to be resilient
Speaker 3: against a range of outcomes, whether that outcome is rising
Speaker 3: or declining, rates, widening or tightening credit spreads. For active managers,
Speaker 3: it allows us to make decisions around liquidity risk management,
Speaker 3: understanding we are an environment where whether it be at
Speaker 3: times a tweet, a policy shift, a FED view that
Speaker 3: can drive rates. You want to have some dry powder
Speaker 3: and liquid to lean into the volatility as it exists.
Speaker 3: With the steep yield curve that I mentioned earlier, David,
Speaker 3: this is an opportunity where active management can really add
Speaker 3: value by exploiting relative value across yield curves, looking for
Speaker 3: opportunities that might arise from differing structures, whether that's thinking
Speaker 3: about hall features, coupon features, and the likes, and then
Speaker 3: so importantly really underwriting credit at the abboog or level,
Speaker 3: because you will have dispersion that continues to persist not
Speaker 3: just from rate volatility, but as credit evolves as we
Speaker 3: move through this cycle. Active managers can really dynamically adjust
Speaker 3: through some of these periods of elevated volatility. Think about
Speaker 3: how they maintain dry powder lean into different opportunities that
Speaker 3: arise through time.
Speaker 1: And so you're especially is muni bonds and you know,
Speaker 1: municipals don't always get the same attention as corporates or treasuries.
Speaker 4: You know, why do you think that's the case?
Speaker 1: And you know what makes it such a compelling asset
Speaker 1: class in this you know today.
Speaker 3: I think municipals have historically not gotten the same focus
Speaker 3: of corporates because when you look at our market is
Speaker 3: broadly speaking a retail focused or high net worth focus market.
Speaker 3: Why should municipals get a lot more attention today? From
Speaker 3: our perspective, there's several reasons, very straightforward for US tax
Speaker 3: paying investors, Municipals offer some of the most compelling relative
Speaker 3: value versus treasuries, versus agencies versus corporates. Today, the tax
Speaker 3: equivalent yields easily pick up anywhere between fifty one hundred
Speaker 3: and fifty basis points, or call it half of a
Speaker 3: percent to one and a half percent. When you take
Speaker 3: that a step further, I think historically investors have thought
Speaker 3: about municipals as.
Speaker 2: Being a key ballast.
Speaker 3: While we're past peak credit quality, likely within the broad markets,
Speaker 3: credit fundamentals for municipal issuers are overall quite resilient.
Speaker 2: Here what you've seen historically if you look.
Speaker 3: At Moody's Who's run a default study going back over
Speaker 3: thirty years, municipals have historically provided much better credit quality
Speaker 3: than that of the corporate market, both measured through very
Speaker 3: low incidents of defaults and higher overall recovery rates. So
Speaker 3: you have both elevated tax exempt income and yield relative
Speaker 3: to other asset classes, but then you also have a
Speaker 3: credit profile that tends to be quite resilient through various
Speaker 3: points of the economic cycle. What I would add with municipals,
Speaker 3: it's an incredibly inefficient market.
Speaker 2: It's one of the most diverse markets out there.
Speaker 3: Forty thousand plus active issuers, which really gets to that
Speaker 3: point that through identifying managers that can navigate through the sectors,
Speaker 3: the ABUCRUZ geographies and structure, you can really add alpha
Speaker 3: and outcomes for clients by finding bottom up relative value
Speaker 3: opportunities within the space.
Speaker 2: You know, why is it overlooked? I don't know, David.
Speaker 3: I've been staring at this market for twenty years, and
Speaker 3: I do think that increasingly you're seeing investors that are
Speaker 3: focused on ensuring that they are fully weighted in both
Speaker 3: the high grade and the opportunistic areas of the market.
Speaker 1: So, you know, as I mentioned at the beginning, you know,
Speaker 1: there was I think twenty four billion in inflows for
Speaker 1: just mutual funds, and you know, when you look at
Speaker 1: the passive side, very little and so you know, obviously
Speaker 1: this is an area where active can provide opportunities. And
Speaker 1: you know, we you know, we all know about the
Speaker 1: tax advantages and you kind of went into this a
Speaker 1: little bit talking about the structural characteristics, but it just
Speaker 1: seems like it's it's a big, big market for active managers.
Speaker 1: You know, what else would you say in terms of
Speaker 1: the structure that really kind of provides those opportunities. You know,
Speaker 1: you mentioned the credit dispersion and just you know so much,
Speaker 1: so many active are so many issuers out there, I
Speaker 1: should say, well.
Speaker 3: I think what's really interesting about our market as well
Speaker 3: is if you try to peel the onion back a
Speaker 3: little bit further and look at I mentioned that the
Speaker 3: number of issues forty thousand plus issuers, and you have
Speaker 3: a lot of the large global issues that people are
Speaker 3: quite familiar with that may issue anywhere between a billion
Speaker 3: to four or five billion in any given year. But
Speaker 3: if then you take a step back and you look
Speaker 3: across states and localities, there's a lot of very small
Speaker 3: issuers that might be looking for financing that's ten million,
Speaker 3: twenty million, thirty million, fifty million, and a lot of
Speaker 3: these smaller bespoke deals don't always get the focus that
Speaker 3: the large global issuers get. If you build a team
Speaker 3: and structure around creating what we like to do as
Speaker 3: a bit of a bar belled approach, as we're venturing
Speaker 3: into the opportunistic space.
Speaker 2: We have your high grade liquidity risk management.
Speaker 3: Think of that as your double A triple A issue,
Speaker 3: large global liquid names that are a ballast within the portfolio.
Speaker 3: But really leaning into some of these bespoke financing opportunities,
Speaker 3: we liken it a time almost to call it the
Speaker 3: private credits of the municipal market in acus a format
Speaker 3: where we can step in and look past benchmarks, look
Speaker 3: past the rating agencies, and look directly to partnering with
Speaker 3: issuers that might have unique financing needs that we are
Speaker 3: able to both underwrite the financials, work with the borrower
Speaker 3: structure the bond covenants for our investors, and also demand
Speaker 3: some level of additional excess yield versus comparable benchmark or
Speaker 3: rated names. And it really creates a lot of opportunities
Speaker 3: to lean into excess yield for investors in what otherwise
Speaker 3: tend to be overlooked. There is the market, and I
Speaker 3: think at times day of what makes it really interesting
Speaker 3: in munis in particular, you have some spots in our
Speaker 3: space that are non rated deals not rated by the
Speaker 3: agencies that I think generally as investors we think non
Speaker 3: rated might mean that these.
Speaker 2: Are sub investment grade.
Speaker 3: The reality means it's just an issue that's not rated
Speaker 3: because they didn't go through the process.
Speaker 2: They might come to me and my team and say,
Speaker 2: we're looking for financing. Can you underwrite the risk?
Speaker 3: If you have the experience and expertise to do that,
Speaker 3: you can really drive good outcomes for clients, primarily through
Speaker 3: targeting elevated yield in otherwise good credits.
Speaker 1: So if we dig a little deeper, what does doing
Speaker 1: the work really mean in municipal credit analysis? Can you
Speaker 1: kind of walk us through the process.
Speaker 3: Yeah, I think doing the work combines a whole host
Speaker 3: of things. It's looking at forensic financials right multi year
Speaker 3: trends and coverage, liquidity, any obligations that might exist on
Speaker 3: the pension or the OPEB side. It's looking at governance
Speaker 3: and management. So what is your budget discipline has been
Speaker 3: depending on the type of bond you have? Rate setting flexibility?
Speaker 3: What is your capital planning credibility through time? Looking for
Speaker 3: things like demand elasticity and demographics. What have enrollment trends
Speaker 3: been in higher education? What might the payer mix be
Speaker 3: in healthcare? For utilities and transport, what is the stability
Speaker 3: of your user base? When we're looking at call it sales,
Speaker 3: tax back bonds, what does the economic environment broadly and
Speaker 3: what does that look like in a specific region. We
Speaker 3: think a lot about security and structure, what's our seniority
Speaker 3: for leans as we think through additional bond tests and
Speaker 3: rate covenant reserve mechanics. And then we're always thinking about
Speaker 3: alternative data and different types of site checks, whether that's
Speaker 3: traffic counts, looking at hospital occupancy as it relates to
Speaker 3: healthcare system tuition, discounting as it relates to higher education,
Speaker 3: water usage, and key areas. So you could see, David,
Speaker 3: it is a wide expanse given just going back to
Speaker 3: the diversity of the medicimal market, and I think what
Speaker 3: you really can appreciate through this, it's the depth of
Speaker 3: thinking through that bottom up analysis, the depth of considering
Speaker 3: governance that allows.
Speaker 2: Us to really drive outcomes and results for investors.
Speaker 1: What about managing risk? Is that just kind of distinguishing
Speaker 1: between the stronger issuers versus the weaker ones.
Speaker 3: It's certainly a key part of it is understanding I
Speaker 3: view it both as where to lean into opportunities where
Speaker 3: we might find an issue that from our perspective, high
Speaker 3: quality issure, mispricedmand to the market at times. Risk management
Speaker 3: is leaning away from some of the hot spots that
Speaker 3: others may not recognize and ensuring that you aren't allocating
Speaker 3: to an issue that we might not believe in their
Speaker 3: credit fundamentals and we feel like they're pricing is too
Speaker 3: tight or spreads are too tight. It risk management for
Speaker 3: us is also liquidity risk management when you're managing through
Speaker 3: the market, whether it's because of the volatility that one
Speaker 3: might anticipate and wanting to ensure that you have some
Speaker 3: dry powder to lean into those periods of volatility that
Speaker 3: might be driven from spreads or rates, whether it is
Speaker 3: also looking through diversification. You heard that from me over
Speaker 3: and over. So when we think about sizing any one
Speaker 3: position across a portfolio, the municipal market, you can hear
Speaker 3: me over and over diversification, diversification. There's a tremendous opportunity
Speaker 3: for us to diversify across state sector. Issuer Alburger structures
Speaker 3: to really sure that as we're making investments, we're protecting clients.
Speaker 2: Risk management is at the heart of everything that we do.
Speaker 1: And so if we just think, you know, take a
Speaker 1: step back and think of you know, you kind of
Speaker 1: went through the whole credit research process. And we've talked
Speaker 1: about how the market is so large and you know
Speaker 1: it's fragmented. How does credit research look different with munis
Speaker 1: versus you know, other types, whether it's treasuries or corporates.
Speaker 3: Well, I think you know, it requires a lot more
Speaker 3: effort given the number of issues that we're trying to canvas.
Speaker 2: Certainly on a daily, weekly or quarterly basis.
Speaker 3: Price discovery in our market is imperfect as well, because
Speaker 3: as you have markets that expand, particularly in those areas
Speaker 3: where it's not a large global issuer, but some of
Speaker 3: these smaller issues, there might be a lot of off
Speaker 3: the run q SIPs or issuers that create some level
Speaker 3: of mispricing. Our view is really simple, if diligent research
Speaker 3: and proactive sourcing can deliver some level of alpha, then
Speaker 3: we want to be there. But that fragmentation of our
Speaker 3: market really amplifies from our view, the value of relationships.
Speaker 3: Technology has certainly enhanced a lot of what we do
Speaker 3: in in identifying opportunities in the market any given day,
Speaker 3: but relationships with dealers, relationships with issuers, access to markets
Speaker 3: become critically important for Expanse in terms of what we're
Speaker 3: able to see day in and day out, just given
Speaker 3: how diverse the market is today.
Speaker 1: So I'll get to technology in just a second, but
Speaker 1: I did want to ask you first, if we take
Speaker 1: another step back and just think about the muni bond
Speaker 1: market as a whole, how should investors kind of think
Speaker 1: about risk in the muni market, especially during periods of
Speaker 1: economic stress? Yeah?
Speaker 3: Well, the interesting thing there, David, is that in periods
Speaker 3: of economic stress us where we're heading into call it
Speaker 3: a broad slow down, which is not our base case today.
Speaker 3: I think we all see that growth continues to be
Speaker 3: quite resilient and positive from here, but we might all
Speaker 3: agree that we're past kind of peak credit fundamentals, both
Speaker 3: for corporate issues as well as municipal issues. But what's
Speaker 3: really interesting, particularly as it relates to some segments like
Speaker 3: general obligation debt for example, is we tend to see
Speaker 3: that in a period of the slowdown, municipality hold up
Speaker 3: quite well. What drives that? Well, if we break down
Speaker 3: general obligation debt very specifically, a lot of times tax
Speaker 3: revenues might be derived from things like property tax values,
Speaker 3: which is not about your market values, about your assessed value.
Speaker 2: And I don't know if you're a homeowner David, I
Speaker 2: certainly am.
Speaker 3: I find that in periods where property values are declining,
Speaker 3: my assessed value tends to say static.
Speaker 2: So the math behind that.
Speaker 3: Equation tends to be pretty advantageous for municipalities to continue
Speaker 3: to have stable revenues even in peers that you see
Speaker 3: a slowdown and declines in the broader macro environment.
Speaker 2: And that really speaks to my comments earlier on looking through.
Speaker 3: Historical time frames where the economy is sewing, and you
Speaker 3: saw municipal credit was quite resilient through those periods, stable
Speaker 3: revenues and the ability to continue.
Speaker 2: To pay debt service.
Speaker 3: What we also look towards is those where are we
Speaker 3: in the capital stack. As a debt holder, you tend
Speaker 3: to be a priority payment. If you're doing your active management,
Speaker 3: you can see how are the reserve funds and ratios
Speaker 3: evolving from here? What does my coverage look like? And
Speaker 3: we take a really active approach in that as well.
Speaker 3: While the reality as municipals tend to do quite well
Speaker 3: through periods of economic stress, our responsibility from a risk
Speaker 3: management perspective is to ensure that Zoe's the case.
Speaker 2: Certainly expect that that's going to be no different today.
Speaker 1: So I do want to get back to technology because
Speaker 1: I think you brought up an interesting point. I mean,
Speaker 1: I'm using technology even just to do fund and ETF
Speaker 1: research now. And so my question for you is, how
Speaker 1: has technology really change the way you fixed income teams
Speaker 1: approach credit research right now, especially in a market like Munie's.
Speaker 3: Yeah, David, that's a great question, and I would say
Speaker 3: it's not just credit research, but also visibility across the market.
Speaker 3: I think back to when I started in the market
Speaker 3: and we had moments where we're still kind of writing
Speaker 3: down buys and sells on paper. What a different world
Speaker 3: that we live in today. So technology, from my view,
Speaker 3: has really meaningfully increased the surface area, whether it's related
Speaker 3: to research, the amount of automated scraping of disclosures, some
Speaker 3: of the natural language processing we can use for transcripts.
Speaker 5: Local news really allows us to have broader visibility into
Speaker 5: what might impact unique credits, and it allows us to
Speaker 5: have even a farther reach in the initial screening from
Speaker 5: a credit perspective.
Speaker 3: On the execution side as well, it's astonishing the execution
Speaker 3: tools that have really helped improve liquidity across the entire
Speaker 3: expanse of the municipal market, it's allowed. You can see
Speaker 3: it certainly within the separately managed account space, which has
Speaker 3: evolved dramatically in the last fifteen years. You have far
Speaker 3: more investors today that access municipals not by buying and
Speaker 3: selling on their own and brokerage accounts, but leveraging managers
Speaker 3: for separately managed accounts. Why have we been able to
Speaker 3: do that so effectively? To customize down to the client level?
Speaker 3: Technology right is at the center of all of that,
Speaker 3: within the human oversight, because ultimately that bottom up credit
Speaker 3: research critically important across high grades and high yield, that
Speaker 3: will always be the case. And then of course stepping
Speaker 3: in and ensuring that portfolios are built in a fashion
Speaker 3: to take advantage of whether it's yield, curve, optimation, sector tilts,
Speaker 3: et cetera. That technology really is helping with both breadth
Speaker 3: and depth across research and portfolio management today.
Speaker 1: And I know people across every industry, not just finance industry,
Speaker 1: are worried about AI and you know, having their jobs
Speaker 1: taken away. And so my question for you is, you know,
Speaker 1: where does human judgment and experience still matter, especially in
Speaker 1: credit research?
Speaker 4: Where could that go into the future.
Speaker 3: It's it is it is a concern, and I'm happy
Speaker 3: to report, David, I think in the municipal market in particular,
Speaker 3: we will continue to keep our jobs, partly because of
Speaker 3: how diversified the market is. Technology is really wonderful coverage,
Speaker 3: speed path or pattern recognition, But when we think about judgments,
Speaker 3: assessing political will, management, credibility, the probability that legislation could
Speaker 3: shift and then change the dynamics around a sector or geography,
Speaker 3: I think a lot of that will continue to be
Speaker 3: human led. At this point, we really think about using
Speaker 3: technology to prioritize some of our inquiries and where we
Speaker 3: want to focus quantify some really high level risk, but
Speaker 3: we use experience to decide.
Speaker 2: When we're going to underwrite and when we're going to
Speaker 2: step aside.
Speaker 3: And we've done a lot of work, David, you can
Speaker 3: imagine our side to really query how can technology not
Speaker 3: just improve our judgment, but at times we've seen where
Speaker 3: it can be faulty, particularly as you get into some
Speaker 3: of the more bespoke areas of a market that are
Speaker 3: not just reliant on feasibility studies, but taking a feasibility
Speaker 3: study and using your own human judgment to say, is
Speaker 3: this going to move forward?
Speaker 1: As planned, well be something to watch. I say, well,
Speaker 1: thank you, Alex. This is a fun discussion. Thank you
Speaker 1: so much for joining me.
Speaker 3: Absolutely, David, I really appreciate it. I do believe we're
Speaker 3: back in one of these bond pickers markets. So it's
Speaker 3: always great to talk about active management.
Speaker 1: Definitely, and since it's my specialties, I always love to
Speaker 1: talk about it. I also want to thank our listeners.
Speaker 1: If you like the episode, please subscribe and leave a review.
Speaker 1: And if you'd like to see more of our research
Speaker 1: on the Bloomberg terminal, go to bi Fund, go for
Speaker 1: Fund and Active Research until our next episode. This is
Speaker 1: David Cohne with Inside Active