In the SNWAM Investment Team’s February strategy meeting, SNWAM municipal bond analysts recommended a market weight for bonds in the dedicated tax bond sector. The neutral recommendation was based on expectations for continued solid relative credit quality, supply being in line with current trends and our determination that the sector is currently at fair pricing levels. Dedicated tax bonds are typically backed by sales or income taxes specifically dedicated for infrastructure projects such as transportation systems or facilities. The pledged tax revenues are also generally carved out from revenues used for operations, or from revenues exceeding annual debt service payments.
Key factors for the stability of the sector are the relative stability of state and local sales and income taxes, and the security provisions associated with most dedicated tax bonds. The downside risk associated with the sector is not necessarily with the level of pledged revenues. It resides in the potential appropriation risk and correlation to the GO and appropriation debt ratings of the jurisdiction associated with the bond issuer, despite the dedicated tax pledges intended to protect bondholders. As such, we prefer dedicated tax bonds that protect bondholders from jurisdictional budget issues and also include investment opportunities that actually provide diversification and credit characteristics distinct from their associated jurisdiction.
As part of our investment process, the SNWAM Investment Team works each month on an in-depth review of a specific municipal bond sector. The review includes an analysis of the sector’s relative credit quality, issuance trends and pricing relative to other sectors in the muni market. The work of SNWAM bond analysts on sector reviews complements their work on reviews of each credit held in SNWAM managed portfolios.