Drawdowns in the bond market this year have left many scurrying for shelter. For investors with liquidity needs or a low tolerance for duration, the front end of the muni market could be just what they’re looking for.
To date, 2022 has been a painful year for investors in most asset classes. However, the fixed income market—municipal bonds specifically—has suffered a drawdown in line with some of the worst in history. Stubbornly high consumer price inflation caused the Federal Reserve to quickly pivot from accommodative monetary policy to hiking six times, bringing the target range between 3.75% and 4%. This policy has contributed to a dramatic increase in nominal interest rates and a significant adjustment of municipal bond valuations.
Municipal valuations, year-to-date changes
Sources: Bloomberg and Thomson Reuters, 11/1/2022. For illustration purposes only. Not a recommendation to buy or sell any security.
Faced with this situation, many investors may feel the need to ask, “Where can I hide”? The answer is the front end of the muni curve (generally seven years to maturity or shorter). The next chart shows the total return year-to-date for various parts of the investment-grade universe. This clearly displays front-end outperformance relative to other tenors of the muni curve. In fact, if an investor simply purchased weekly reset variable-rate demand notes (VRDNs) and held them throughout the year, they would have outperformed all other segments of the muni universe.
Variable-rate demand notes
Source: Bloomberg, 10/31/2022. For illustration purposes only. Not a recommendation to buy or sell any security.