Municipal bonds have performed well so far in 2016 as evidenced by the nearly 3% return in the iShares National Muni Bond ETF (MUB) .
A lot of that performance results from good old supply and demand, said David Dowden, portfolio manager from MacKay Municipal Managers. Demand in the municipal market has been significant with year-to-date mutual fund inflows of $33 billion through June.
So far this year, there has been $221 billion in new issuance through June 2016 with 60% of that new issuance representing refinancings and advanced refundings.
"We believe technical factors will continue to play a heightened role in driving returns in 2016," said Dowden. The year began with heightened market volatility in January and February. The Brexit referendum lifted economic uncertainty further, perpetuating choppiness in global markets. That market uneasiness has generally benefited muni-bond holders.
Revenue bonds have outperformed in 2016 as investors preferred defined revenue streams over pension uncertainty. Through June, the revenue bond segment of the Barclays Municipal Bond Index returned 4.82%, outperforming the general obligation segment by 86 basis points, which returned 3.96% during the same period. Through June, the Barclays Municipal Bond Index returned 4.33%.
In terms of sectors, transportation has returned 4.95%, outperforming the Barclays Municipal Bond Index by 62 basis points.
"Transportation bonds will continue to benefit from a strong economy and higher government commitment to financing new projects," said Dowden.
At the start of 2016 Dowden recommended that investors "spring into high-yield municipals" for the first half of the year and then "fall back to investment grade." Thus far his forecast has been on target. Through June, the Barclays High Yield Municipal Bond Index has returned 7.98%, almost double the Barclays Municipal Bond Index.
"The strong demand we saw in the first half has led to tighter credit spreads," said Dowden. "We think investors will realize they are not getting paid enough to buy riskier assets, even when it comes to munis."