HedgeRoll - Value Investing and After Tax Returns
  • HedgeRoll
  • Contact
  • Research

hedgeroll

In Search of After-Tax returns

Muni Bonds predicted the last market crash, and now they are saying this...

5/28/2016

0 Comments

 

Bad things happen when people misprice risk. 

From the credit crisis of 2008, to the tech bubble of 2000, to the panic of 1873, all are the product of human misjudgement regarding risk.

Below, I present evidence of a current mispricing in one corner of the credit market. This same phenomena preceded nearly every equity market correction over the past thirty years.

I used to work in Municipal Bonds, both buyside (mutual fund shop) and sell-side (bank trading desk). I now follow muni bonds as an allocator at a family office.

High yield munis have a greater yield than investment grade munis. 

How much more yield? Glad you asked...

High yield muni bond funds have been around for a long time. MFS Municipal High Income (MMHYX) has been around since 1984. We can compare the yield on this fund to an investment grade fund, Vanguard Long-Term Tax-Exempt (VWLTX), to get a sense for "How Much More Yield".

Over the past 30 years, high yield munis have yielded 124% of investment grade muni bonds, on average. This ratio is illustrated below. The lower the line, the less investors are being paid to take on high yield credit risk. 

Picture


What is the current yield ratio?
​
115% and dropping, compared to a long term average of 124%.

Relative to investment grade munis, high yield is very, very expensive. Mispriced risk, illustrated.

Perhaps something has changed over the past few years to make high yield muni credit fundamentally less risky than it has been in the past, but I doubt it. In fact, with the reduced role of municipal bond insurers since the credit crisis, muni bonds are likely more risky.
​
You may be thinking... so what if high yield munis are overvalued, just don't buy them. 

Yes, but notice what happens to the equity markets when the yield ratio gets to 115% or lower.

​1987:

Picture

1990:

Picture

1998:

Picture

2007:

Picture

2016?

Picture
So muni bond yield ratios predict stock market corrections? Not really. I would say that over-reaching for yield tends to happen before inflection points in the market. Investors stop respecting risk, and then they pay.

Right now, if high yield muni investors are over-reaching, you can bet some other investors are too. If you want to learn more about high yield municipal bond,I recommend this book.
​
The obvious answer: buy gold and bury it in your backyard.

In all seriousness, make sure you are being compensated for the risks you are taking... check your asset allocation, it might be time for a rebalance.

Sign up for emails.

I will only email you when I have something interesting to share.
Email Marketing You Can Trust

I am my own worst critic, so here are a few critiques of the above analysis:
  • MFS Municipal High Income (MMHYX)  is not a perfect proxy for the Muni HY market. It's actively managed, so that brings some bias into it. ​ However, no HY Muni index funds go back to the mid 80's. If you used an index fund, it would tell the same story, but with shorter time frame.
  • TTM yields are not the best measurement of yield.  Yield to worst would be better, but I don't have that historical data. 
  • Ideally MMHYX and VWLTX would be very similar except credit quality. They are not, and that  brings in some bias. For example, MMHYX currently has an effective duration of 7.43, while VWLTX has a duration of 6.38. There are likely numerous examples one could find that show this is not an perfect apples-to-apple comparison.
0 Comments

Your comment will be posted after it is approved.


Leave a Reply.

    Picture
    This is the personal blog of Emory Redd.

    This blog is not investment advice. This is not a solicitation to invest. Don't take candy from strangers.
    Follow @Emory_R
    View my profile on LinkedIn
    BEST OF HEDGEROLL
    ACHILLION AND RA CAPITAL: MY FAVORITE TRADE

    SALIX INVESTORS LOOKING FOR A BUYOUT SHOULD BE CAUTIOUS; MORE ACCOUNTING PROBLEMS AHEAD

    BIOTECH AS BUFFETT'S WONDERFUL BUSINESS
    Get Email Updates

    Categories

    All
    13D
    13F
    13G
    Abingworth
    Accounting
    Accounting Fraud
    Achillion ACHN
    Activist
    AGN
    Aig
    Alphasimplex Group
    American Express
    Andrew Lo
    ANTH
    Anthera Pharmaceuticals
    Anthony Scaramucci
    Arbitrage
    ARC-520
    Argonaut Capital Management
    Arrowhead Research
    Artemis
    ARWR
    ASH 2014
    Avenue Capital
    AXP
    Baker Bros. Advisors
    Baker Brothers
    Barton Biggs
    Baupost Group
    BB Biotech
    Bear Stearns
    Beneish M-Score
    BenjaminJGarber.com
    Bershire Hathaway
    Bill Gross
    Biotech Hedge Fund
    Biotechnology
    Biotech Trader Handbook
    Biotech Valuation
    Black Swan
    BMY
    Bob Treue
    Bonds
    Books
    Broadfin Capital
    Bruce Greenwald
    Bubble
    Capital Returns Management
    Carl Icahn
    Carlos Slim
    Carnegie Mellon
    Celgene (CELG)
    Channel-stuffing
    Charlie Munger
    China
    Chris Levett
    Circle-of-competence
    Clive Capital
    Coca-Cola Company
    Coke KO
    Columbia Business School
    Commodities
    Contrarian Trades
    Credit
    Credit Bubble
    Cta
    Currency
    Daniel Gold
    Data Mining
    David Einhorn
    David Gerstenhaber
    David Harding
    David Tepper
    Davita Inc
    D.E. Shaw
    Deutsche Bank
    Donald Trump
    Dunn & Bradstreet DNB
    Dva
    Earnings Manipulation
    Eric Sprott
    Fabozzi-books
    Fed Day
    Federated Investors
    Fees
    Fig
    Fixed Income
    Form 4
    Fortress Investment Group Llc
    Fund Of Funds
    Gartmore
    GILD
    Gilead
    Glaxosmithkline
    Global Macro
    Gold
    Goldman Sachs
    Gotham Capital
    GSK
    HBV
    HCV
    Hedge Fund Start-up
    Hepatitis B
    Hepatitis C
    HIV
    Humor
    IBM
    IgA Nephropathy
    Inflation
    Insurance Companies
    Intellectual Property
    International Business Machines
    Izzy Englander
    Jeffrey Ubben
    JNJ
    Joel Greenblatt
    John Paulson
    Johnson & Johnson
    John W Henry
    Julian Robertson
    Kkr
    KO
    Leon Cooperman
    Loeb
    Long Term Capital Management
    Lupus
    M&A
    Man Group
    Marc Lasry
    Mellon
    Michael Bloomberg
    Michael Burry
    Michael Lewis
    Michael L Roirdan
    Michael Novogratz
    Michael Steinhardt
    Millennium Partners
    Moody's MCO
    Mr. T
    MRX
    Municipal Bonds
    Music
    Nassim Taleb
    Obama
    Occupy Wall Street
    Oil
    Omega Advisors
    Oncology
    Orbimed Advisors
    Orphan Disease
    Palo Alto Investors
    Paul Tudor Jones Iii
    Perceptive Advisors
    Pershing Square
    PG
    Pharmacyclics (PCYC)
    Phil Falcone
    Point State Capital
    Private Equity
    Procter & Gamble
    Quantitative Easing
    Quants
    QVT Financial
    RA Capital
    Redmile Group
    Return On Invested Capital
    Rob Bobman
    Robert Shiller
    Rob Goldstein
    ROIC
    Salix Pharmaceuticals SLXP
    Sanofi-Aventis
    Sebastian Mallaby
    Sec
    Seeding
    Seth Klarman
    Shorts
    Short Selling
    Short Selling Books
    Silver
    Skybridge
    SLXP
    SNY
    Stanley Druckenmiller
    Statistical Arbitrage
    St Joe Company
    Sub-Prime
    Ted Weschler
    The Barnegat Fund
    Thomas Mellon
    Traxis Partners
    Twitter
    Twitter Hedge Fund
    Valeant
    ValueAct
    Value Investing
    Vanderbilt
    VHCP Management
    Victor Niederhoffer
    VRX
    Warren Buffett
    Warren Buffett Letters
    Wells Fargo
    Wfc
    When Stocks Crash Nicely
    William Ackman
    Winton Capital Management
    Wonderful Business
    Yale University

    Archives

    December 2016
    August 2016
    June 2016
    May 2016
    April 2016
    March 2016
    June 2015
    May 2015
    April 2015
    March 2015
    February 2015
    December 2014
    November 2014
    October 2014
    August 2014
    April 2014
    August 2013
    October 2012
    September 2012
    May 2012
    April 2012
    March 2012
    February 2012
    January 2012
    December 2011
    November 2011
    October 2011
    September 2011
    August 2011
    July 2011
    June 2011
    May 2011
    April 2011
    March 2011
    February 2011
    January 2011
    December 2010
    November 2010
    October 2010
    September 2010

    RSS Feed

Powered by Create your own unique website with customizable templates.
  • HedgeRoll
  • Contact
  • Research