- Positive technical factors produce tighter spreads
- Stable credit profiles, lower defaults aided performance
- Credit selectivity, sector diversification are keys to performance
Fundamentals in the municipal high yield market improved in the first quarter. With the exception of Puerto Rico and the Virgin Islands, the credit environment was stable to better across the tax-exempt market. Financial reporting from issuers shows positive trends in ratios and margins, while default rates, both technical and actual, remain below historical trends.
New municipal bond issuance declined considerably from last year and was much lower than longer-term averages, which supported prices. Also helping was reduced market anxiety over the prospects of sudden and drastic changes in healthcare laws, tax reform, and the inflationary prospects of large deficit spending on infrastructure.
Continued improvements in the economy, solid credit profiles, and lower primary issuance have resulted in spread tightening and good performance in the municipal high yield market. Also assisting performance is the return to positive municipal high yield fund flows, which highlights the important role fund flows have generally.
While yields on high yield municipals have declined somewhat from their highs of last November, in our opinion they remain attractive. We believe emerging market high yield corporates and U.S. leveraged loans continue to be favored asset classes. Their yields are similar to those of U.S. high yield corporates while also benefiting from better overall credit quality and lighter overall market positioning.
Active management in credit selection and sector diversification remain the keys to managing risks and generating strong returns in the high yield municipal and taxable markets. For example, when yields and credit spreads on U.S. high yield corporates declined to a two-year low during the first quarter, nimble managers were able to swap in similar yielding leveraged loans and reap the benefits of the floating rate loan structure while also lowering credit risk.
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