Municipal bonds
Interview: National City Investment Management---Carpenter, Stephen---Fund Manager (slow)
>> welcome back to the “world financial report”. municipal bonds usually outperform taxable bonds during rising interest rate environment. our next guest currently favors general obligations and real revenue bonds like water and sewer bonds. that man is steven carpenter, senior portfolio manager at the armada funds. he helps oversee around $5 billion in tax exempt income and joins us from their offices in the city of cleveland, ohio. thanks for being on the program.
>> thank you, bob.
>> let me be devil’s advocate here and argue with you in this way. some might say it’s a terrible time to invest in municipal bonds because estate debt is so high, so just california. the federal government canneds the states can’t help the towns because they are in so much debt. the federal government is in so much debt it can’t help the state. we may be setting the stage for a record number of municipal bond defaults. why is that logic wrong?
>> it’s not that the logic is overly wrong. it’s just that it extends today’s current environment out into the future. i think at armada we are thinking more about the fact that full faith in credit, general obligations of most states, cities and counties will be fine. i mean they have to balance their budget. because of that their spending will be cut. taxes will be raised and those budgets will be balanced in time. also as the economy starts to get better, remember, a lot of these people get sales tax revenue, income tax revenue starts to get better, so things will probably be better down the road. i think we are seeing the worst time for municipal credit right now. not in the future.
>> ok. and let me understand what you mean when you say it’s the worst time right now and you predict interest rates will go up. does that mean that i would be dumb to buy municipal bonds now because i would be locking in lower yields?
>> no, no. because right now municipal bonds are trading, good quality municipal bonds are trading at 90% of the treasury market right now, which is historically high, 10-year area. i think what we see at armada over time is as the economy gets better, thus interest rates rise. when interest rates rise, tax exempts will trade down around 75% of treasuries. so obviously any appreciation in principal is not as big in a rising interest rate environment as it is in the treasuries and even the corporate market.
>> but isn’t the issue not so much how they perform relative to treasuries? the issue is what kind of return they give you. right? in other words, where prices go in muni bonds. you might argue if everyone is moving their money into equities because the economy is rebounding and they are taking money the of the bond market, then their prices will go down.
>> our philosophy here at armada is a little different. our philosophy is it’s not what you make, it’s what you get to keep that really matters. what we are looking for is income. right now when your income on tax exempt bonds 10-year area, 3&3 quarters, up toward 4% for a little lower quality, that’s a taxable equivalent of better than 6% versus the 30-year market. this is on a long-term basis a very good return. don’t worry about the day-to-day bond fluctuation. the reason you go into municipal bonds with municipal bond funds is to garner income. not that you want to expose this principle pal to a lot of f’s, but on a shrm basis, it’s a long-term basis that matters.
>> i understand you are thumbs up on water and sewer authorities and more thumbs down on local hospitals, that kind of thing. take us through the sectors.
>> well, through the sectors, taxes will be raised. i think at armada we look at water and sewers, those are essential services. when you are looking at what people will do with their money, they are going to have to have water, they are going to have to have sewers. this is something that is an essential service provided by most government entities. those bills are going to be paid. as far as hospitals are concerned, here at armada our analysis shows the four things to be careful of. we call them the four m’s with hospitals. that’s medicare, medicaid, malpractice, and mall fee zans, and it’s really hard to get your hands around all those. we say we tread very carefully when we get into the hospital arena.
>> however, i would think an aging baby boomer demographic would mean a need for more hospitals.
>> yes, but who is going to pay for it? if you look at where medicare careand medicaid and the malpractice, where the revenue comes from, hard to get your arms around each hospital. the financial data is late, sometimes a year in arrears. it’s very hard to look at it. it’s why they really need professional management to look at these things.
>> help me understand the decision between a muni bond fund and the municipal bonds themselves, investors watching this program making that decision, of course, the bond fund offers diversification. assuming someone has enough capital to spread it around a bit and buy some of the bond funds themselves, rather the bonds themselves, if they buy the direct bonds they won’t have to with all due respect, pay salaries for people like you. why is a bond fund better?
>> a bond fund is better for people probably holding on to $3 million or less in municipal bonds. it’s just very hard, round lots are $100,000, $200,000 before you get any type of price in the market. the market is not quite as seamless as it looks on the stock exchange or somewhere else. because of that to get good value you really have to be in that market every day. most individuals are not in that market every day. because i that, i think unless you have a lot of money then you go out and hire a professional manager to run it. but the mutual funds, the other thing about mutual funds is they tend to pay monthly interest. most bonds pay every six months. so when you are looking at that, for people looking for just the income component, it’s a nice spending streak to come.
>> we are out of time. steven crawford with the armada fund.
