Terry Goode, senior portfolio manager for the high-yield municipal bond approach at Wells Fargo Asset Management discusses managing concentration risk for investors.
Laurie King: I’m Laurie King, and you are listening to On the Trading Desk®. While the high-yield municipal bond market remains attractive, there are risks to consider. Terry Goode, senior portfolio manager for the high-yield municipal bond approach at Wells Fargo Asset Management, is keeping close watch on one in particular—concentration risk.
Terry’s name might be familiar to you. You saw him in our 2018 Midyear Investment Insights video, “Expand, Adjust, Adapt”. When we filmed his insights, we asked a few more questions to go deeper into what’s influencing the high-yield muni space and how he’s managing it for investors. Here’s Terry, bringing us up to current.
Terry Goode: The muni market has actually done really well over the last three years. Returns have really been strong. There’s been a lot of demand for municipal bonds—with limited supply. So that’s really increased bond prices.
Laurie: But what we need to know about the high-yield muni space, at present, is that it’s concentrated, it’s very concentrated, in a couple of ways. Terry goes on to explain one area of concentration risk—companies who hold the most assets.
Terry: It basically means that the high-yield muni space is controlled by a very few players in the market. The top five mutual fund holders of high-yield debt—it’s 45%. And the top holder has 20%. And so if those particular players have any sort of issues with outflows and have to sell their bonds, that could really impact our market.
Laurie: Terry’s also seeing concentration risk in specific bonds
Terry: The high-yield muni market is concentrated in tobacco settlement bonds and Puerto Rico debt. And in a concentrated market, if you were to see outflows, likely tobacco settlement bonds and Puerto Rico bonds would be sold at a very significant level. And that would cause those bond prices to go down significantly. We don’t own either of those securities. What we try to do is maintain sufficient liquidity so that we can be a net provider of liquidity in that particular situation, and never to be a forced seller.
Laurie: So the team’s sector and credit exposure varies based on relative value opportunities. As they think about relative value, they consider a number of factors that blend their top-down macro inputs, such as avoiding the areas of concentration that we just spoke about— with bottom-up fundamental considerations, such as the specific credit worthiness of an issue. They’re always looking at the relative value of an issue, meaning, are they getting paid for the risk of a particular bond—said another way, they want to avoid investing in uncompensated risk. So let’s hear what Terry says about security selection.
Terry: What we’ve been able to do is really use our security selection to buy some of the better deals in the high-yield market. Ones that are going to have staying-power, ones that are not going to trade off significantly with widening credit spreads, which you may see as interest rates begin to rise.
Laurie: Terry credits dedicated credit research.
Terry: We have 15 dedicated municipal credit analysts. They sit on the trading desk with us. They’re not only doing credit research, but they’re also making an investment recommendation—so they are incorporating relative value. I think that’s a big difference. When you look at our competitors, they’re assigning credit ratings and they leave it to the portfolio managers to make the investment decision. For us, it’s really team managed. And so our analysts have really kept us out of some issues that have really gone bad for others. We were early in not buying Puerto Rico—initially that hurt us—but ultimately we do think that’s going to pay off for us. So, that’s one of the nuances that I think differentiates us.
Laurie: Terry also speaks to having access to a broader, global set of fixed-income investment expertise to share ideas and add value for investors.
Terry: I would like for our investors to consider that we view the market holistically. That we’re not simply looking at the municipal high-yield market but we’re looking at other markets that may influence our market, such as the corporate bond market and emerging markets. There’s also geopolitical risk that we have to assess. And there are certain takeaways that we can glean from those areas that may influence our market. So often, that can allow us to be a bit earlier to the game than some of our competitors.
Laurie: We’ll end this episode on that note and thank Terry Goode for his insights. Learn more about his team and their high-yield municipal bond approach by visiting http://on.wf.com/6122DxvB8. Until next time; I’m Laurie King, take care.
Mutual fund investing involves risks, including the possible loss of principal. Foreign investments are especially volatile and can rise or fall dramatically due to differences in the political and economic conditions of the host country. These risks are generally intensified in emerging markets. Consult a fund’s prospectus for additional information on risks.
Bond values fluctuate in response to the financial condition of individual issuers, general market and economic conditions, and changes in interest rates. Changes in market conditions and government policies may lead to periods of heightened volatility in the bond market and reduced liquidity for certain bonds held by the fund. In general, when interest rates rise, bond values fall and investors may lose principal value. Interest rate changes and their impact on the fund and its share price can be sudden and unpredictable. High-yield securities have a greater risk of default and tend to be more volatile than higher-rated debt securities. The use of derivatives may reduce returns and/or increase volatility. Certain investment strategies tend to increase the total risk of an investment (relative to the broader market). A portion of a fund’s income may be subject to federal, state, and/or local income taxes or the alternative minimum tax. Any capital gains distributions may be taxable.
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