Muniland: Sector Outlook–Did Someone Say Corp-icipal?

As part of our investment process, SNWAM analysts make weighting recommendations for each sector in the municipal bond market, in addition to reviewing each credit held in SNWAM managed portfolios. Each month, a specific sector is the subject of an in-depth review, which includes an analysis of the sector’s relative credit quality, issuance trends and pricing relative to other sectors in the muni market. The corporate backed municipal sector was the focus of SNWAM analysts’ October review. 

SNWAM is underweight the corporate backed municipal sector based on our review of credit characteristics, expected supply and pricing levels. The sector is diverse and includes financial institutions, investor owned utilities and non-cyclical industrials. Though this sector may sound like a misnomer, the purpose of the debt issuance meets the criteria of serving a public good. Our sector score is in the underweight range because of generally late business cycle risk and tight credit spreads. However, we still believe there are opportunities in the sector through prudent security selection. While this is not the time to chase the corporate bond rally, it is also not the time to take risk off the table. Corporate backed municipals generally follow the pricing trends of their corporate taxable equivalents, but generally exhibit less pricing volatility. Therefore, while we can anticipate wide price swings in the taxable corporate bond market when risk spikes, the spread widening is generally more subdued for corporate municipals. We find that the additional yield of the corporate backed municipals and relatively higher beta can help generate positive security selection.

Specifically, we find attractive security selection opportunities in defensive sectors such as utilities and non-cyclical industrials. We prefer to take utilities and non-cyclical municipal exposure in the front end of the curve and we favor bonds with “put” structure risk. The BBB-rated category of non-cyclical industrials with short maturities provides value as it is recession resistant and its lower ratings are more a function of higher leverage than weak business fundamentals. We also find value in high-quality financials, as banking regulation has tightened and capital buffers increased. In all, SNWAM is underweight this sector, but continues to find opportunities to generate above benchmark yields through prudent security selection.

Source: SNWAM  Research