Podcast Summary: The Long View – Jim Murphy and Charlie Hill on Municipal Bonds

Episode: *Jim Murphy and Charlie Hill: ‘The Value Proposition for Municipal Bonds Has Rarely Been Stronger’
Release Date: November 12, 2024
Hosts: Dan Lefkovitz and Christine Benz
Guests: Jim Murphy and Charlie Hill from T. Rowe Price's Municipal Bond Investment Team

Introduction to Guests and Municipal Market Overview

In this episode of The Long View, hosts Dan Lefkovitz and Christine Benz welcome Jim Murphy and Charlie Hill from T. Rowe Price's municipal bond investment team. Jim leads the team and manages several high-yield municipal strategies, while Charlie, with over three decades at T. Rowe Price, oversees short and intermediate-term municipal bond funds. Morningstar's manager research has lauded T. Rowe Price’s municipal bond capabilities, awarding several of their strategies gold medalist ratings.

Recent Performance of Municipal Bonds

Jim Murphy begins by highlighting the volatility in the municipal bond market over the past few years. He recalls a period of relative calm from 2015 to 2020, characterized by low interest rates and uninteresting spreads. However, the onset of the COVID-19 pandemic in March 2020 introduced significant volatility, with cash and treasuries soaring as other assets were crushed.

“We’re past this very significant Fed rate reset. So rates are at 10 to 15-year highs,” Murphy notes [04:02]. He emphasizes that the current environment offers a strong value proposition for municipal bonds, with high real yields and robust credit quality bolstered by improved fiscal health in state and local governments post-COVID.

Impact of Recent Rate Cuts

Charlie Hill discusses the implications of the recent 50 basis point rate cut—the first since 2020—and its effects on the muni yield curve. He explains that the inversion in the municipal curve, where shorter-term bonds yield more than longer-term ones, has lessened but still exists.

“The overnight municipal rate has come down from about 3.3 to 3%,” Charlie explains [04:48]. He outlines how these rate changes influence investor behavior and the overall yield environment, noting the interplay between treasury yields and municipal bond rates.

Researching a Fragmented Municipal Market

Navigating the expansive and fragmented municipal bond market is a challenge that Jim Murphy addresses with enthusiasm. He describes the market as “a large market of small issuers” and underscores the importance of thorough credit research and active management.

“We think it really lends itself to bottom-up analysis,” Murphy states [07:08]. He highlights the value of having dedicated researchers and maintaining boots-on-the-ground presence to uncover high-quality, off-the-beaten-path municipal bonds that offer reasonable yields.

Mutual Funds vs. Individual Bonds

Charlie Hill delves into the perennial debate between investing in mutual funds versus individual municipal bonds. He outlines the advantages of mutual funds, including professional management, holistic portfolio assessment, and the ability to manage interest rate and credit exposure effectively.

“If you hire a professional to do it for you, they take a holistic view of your entire portfolio,” Charlie explains [09:38]. He contrasts this with individual bond investing, where managing tax loss recognition and maintaining portfolio risk can be cumbersome for individual investors.

Investment Flows and Current Trends

The conversation shifts to investment flows within the municipal bond space. Charlie Hill reports a positive trend with approximately $25 billion in inflows year-to-date, reversing nearly $140 billion lost over the previous two and a half years.

“Flows have recently turned positive in the ETF and mutual fund space,” Charlie observes [13:39]. He attributes this rebound to investors returning to fixed income as equity markets become less attractive and recognizes the importance of rising interest rates in revitalizing demand for municipal bonds.

Impact of Upcoming Elections on Municipal Bonds

With the U.S. presidential election on the horizon, Jim Murphy discusses potential implications for the municipal bond market. He anticipates a divided government outcome, which could influence corporate tax rates and the Alternative Minimum Tax (AMT).

“If Vice President Harris gets elected, we could expect higher tax rates across the board,” Murphy contemplates [17:09]. He suggests that increased demand for tax-exempt income from higher tax rates would bolster the municipal bond market.

Charlie Hill adds that the fate of the AMT could significantly impact investor behavior, particularly concerning tax-exempt income.

“The AMT relief sunsets at the end of 2025 unless they reach an agreement,” Charlie notes [19:45]. He emphasizes the importance of monitoring legislative changes that could affect municipal bond attractiveness.

Geographic Considerations in Municipal Investing

Geography plays a crucial role in municipal bond investing. Charlie Hill discusses the challenges associated with states like Illinois, which have historically struggled with fiscal issues. He contrasts this with Sunbelt states experiencing population growth and increased issuance needs, particularly in Texas and Florida.

“We are spending as much time as we can really looking at some of these coastal regions more carefully,” Jim Murphy adds [40:00]. He highlights the nuanced opportunities arising from population shifts and the resulting infrastructure demands in growing states.

Credit Quality Assessment in Municipal Market

Assessing credit quality is vital in the municipal bond market. Jim Murphy explains that quality spreads in munis are positively correlated with interest rate movements and are currently healthy.

“Quality spreads are about... one standard deviation tight to where they've been in the recent past,” Jim assesses [27:04]. He underscores the strong fiscal health of state and local governments, supported by improved income statements and balance sheets.

High Yield Municipal Bonds

High yield municipal bonds offer enhanced income potential with manageable risk. Jim Murphy clarifies that high-yield in the muni space refers to higher-than-average yields rather than true junk bonds.

“The municipal market is a very, very high-quality market with a very low default rate,” Jim asserts [46:08]. He advises using high-yield municipal bonds as a yield enhancement within a broader, higher-quality bond portfolio, balancing additional income with limited default risk.

ETFs, Mutual Funds, and SMAs in Muni Investing

The discussion moves to the various investment vehicles available for municipal bonds. Charlie Hill explains that while ETFs provide passive management and liquidity, actively managed mutual funds offer superior income through targeted research.

“The extra income that you get through an active manager... will accrue to the benefit of the mutual fund or active ETF holder,” Charlie states [50:13]. Jim Murphy emphasizes the growing demand for actively managed ETFs and mutual funds, anticipating a shift towards these products over the next five years as investors seek active management’s added value.

“We're going to meet the client where they want to get their tax-exempt Alpha from,” Jim concludes [50:23]. He notes that while ETFs are gaining traction, mutual funds remain the primary avenue for active municipal bond investment.

Conclusion and Final Insights

As the episode wraps up, the guests reflect on the resilient and opportunistic nature of the current municipal bond market. Jim Murphy underscores the strategic positioning of municipal bonds given the current interest rate environment and strong credit quality.

“The exemption just feels a heck of a lot more valuable to individual investors at higher rates,” Jim remarks [23:31]. Both Jim and Charlie convey confidence in the municipal bond market’s prospects, driven by favorable fiscal conditions, rising yields, and sophisticated management strategies.

“It's been an absolute pleasure,” Jim concludes, thanking the hosts for the insightful discussion [51:43].

Notable Quotes:

• Jim Murphy on market volatility: “One day in the stock market could be a year in the muni market in terms of volatility.” [01:35]
• Charlie Hill on rate curve inversion: “The inversion still exists today, although it's not as pronounced as it was back in the summer of 2024.” [04:48]
• Jim Murphy on research advantages: “If you can do that, then you can really add value in real time.” [07:08]
• Charlie Hill on mutual funds vs. individual bonds: “Another item obviously is going out and doing the due diligence on individual credits.” [09:38]
• Jim Murphy on election impact: “If Harris gets elected, we could expect higher tax rates across the board.” [17:09]
• Charlie Hill on AMT implications: “It might have a terrible impact if it gets reinstated, but we'll see.” [19:45]
• Jim Murphy on tax-exempt status: “We think it was very clear to us that they were so massively over-leveraged.” [40:00]

This episode provides a comprehensive analysis of the current state and future prospects of the municipal bond market, emphasizing the enhanced value proposition due to rising interest rates, strong credit quality, and strategic management. Jim Murphy and Charlie Hill offer expert insights into navigating a complex and fragmented market, making this episode valuable for investors seeking reliable, long-term tax-exempt income opportunities.