High Yield Municipals Best in Class
Key Points
- Coupon income to drive positive, albeit moderate, returns in 2022
- Credit trends should continue to benefit from an improving economy
- Market dislocation should create attractive entry points for investors
High yield municipal (HYM) bonds got back on track during 4Q2021 to close out an otherwise volatile year for fixed income assets. According to Bloomberg and Barclays indices, HYM added more than 100 bps of total return during the quarter, propelling full-year gains above 7.75% and delivering relative solid outperformance.*
The technical underpinnings that persisted for most of the year, such as positive fund flows, along with a fundamental improvement in credit quality from a recovering economy, contributed to higher prices of HYM bonds that position the asset class well to begin 2022. Total returns should moderate in line with “clipping your coupon.” That said, HYM bonds are poised to outperform investment grade municipals and Treasuries, providing above-market income and an inflation cushion for investors.
Our forecast for more limited return upside potential reflects narrow credit spreads that compressed significantly throughout 2021 as investors felt more comfortable assuming additional issuer risk in an otherwise low-yield environment. However, given our favorable outlook for the economy and GDP growth in 2022, HYM bonds could remain at current valuations for some time, particularly in the short run, as demand and supply imbalances point to continued price support. A risk to the downside could develop toward the back half of 2022 (or sooner) as policy accommodation diminishes. Should municipal market demand weaken (i.e., slower fund flows or intermittent outflows) and rates react more aggressively to a shift in monetary policy, HYM bond performance could undershoot estimates. Still, we view these events as opportunities for investors to take advantage of more attractive valuations and to book incremental yield.
Issuer credit quality should benefit from an improving economy in 2022. HYM could experience an uptick in troubled borrowers should market access wane, but this would be unlikely to create a systemic challenge to the generally constructive credit backdrop. While the year-end 2021 market par value in default was less than 0.4% (ex- Puerto Rico), City National Rochdale continues to exercise diligent security selection and sector bias within the HYM space to avoid unnecessary risk exposure for client portfolios.
* Indices are unmanaged and one cannot invest directly in an index. Index returns do not include fees for trading costs (i.e., commissions) or any fees charged by your financial advisor, custodian, City National Rochdale or other third-party managers, and if they were included would reduce the returns.
Important Disclosures
Important Information
Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.
Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not re-flect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.
Concentrating assets in a particular industry, sector of the economy, or markets may increase volatility because the investment will be more susceptible to the impact of market, economic, regulatory, and other factors affecting that industry or sector compared with a more broadly diversified asset allocation.
Private investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information.
Alternative investments are speculative, entail substantial risks, offer limited or no liquidity, and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying and lengthy lockup provisions. Please see the Offering Memorandum for more complete information regarding the Fund’s investment objectives, risks, fees, and other ex-penses.
Investments in below-investment-grade debt securities, which are usually called “high-yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell and their prices can be more volatile than more highly rated securi-ties. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a high-er-quality rating.
There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve height-ened risks related to the same factors, as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.
There are inherent risks with fixed-income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed-income securities and during periods when prevailing interest rates are low or negative. The yields and market values of munici-pal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain inves-tors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in be-low-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guar-antee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.
Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.
Alternative investments are speculative, entail substantial risks, offer limited or no liquidity and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying, and lengthy lockup provisions.
This material is available to advisory and sub-advised clients, as well as financial professionals working with City National Rochdale, a registered investment advisor and a wholly-owned subsidiary of City National Bank. City National Bank provides investment man-agement services through its sub-advisory relationship with City National Rochdale.
Index Definitions
S&P 500 Index: The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes.
Bloomberg Barclays US Aggregate Bond Index (LBUSTRUU): The Bloomberg Aggregate Bond Index or “the Agg” is a broad-based fixed-income index used by bond traders and the managers of mutual funds and exchange-traded funds (ETFs) as a benchmark to measure their relative performance.
GT2 Govt, GT3 Govt, GT5 Govt, GT10 Govt, GT30 Govt: US Government Treasury Yields
DXY Index: The U.S. dollar index (USDX) is a measure of the value of the U.S. dollar relative to the value of a basket of currencies of the majority of the U.S.’s most significant trading partners.
Dow Jones U.S. Select Dividend Index DJDVP: The Dow Jones U.S. Select Dividend Index looks to target 100 dividend-paying stocks screened for factors that include the dividend growth rate, the dividend payout ratio, and the trading volume. The components are then weighted by the dividend yield.
Non-deposit investment Products are: • not FDIC insured • not Bank guaranteed • may lose value
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