It also may be the best strategy for municipal bond investors in 2013, given market conditions. So says Peter Hayes, head of muni-bond portfolio management, research and trading at BlackRock.
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In his more than 25 years on the municipal bond desk at Merrill Lynch and BlackRock, Hayes has had front-row seats to some of the biggest changes in asset management, and in particular how they have affected muni bonds.
He brings all of his experience to bear in his near-term outlook on the market, including where to find value, his stance on ratios and returns, and how negotiations in Washington, D.C., for the debt ceiling will affect munis.
“I’ve seen both sides of the market,” said Hayes, who oversees $109 billion in muni assets under management at BlackRock. “I was on the sell-side, so I can appreciate how important the liquidity they provide is to the market. And now I’m on the buy-side, which has a different view, and a different way to think about and implement strategy; it’s more of a longer-term view than a near-term view.”
That longer-term view helps him see into the matter of munis’ tax-exemption status. The issue probably won’t be resolved as part of the debt ceiling discussions, Hayes said.
Rather, it’s most likely to take place as part of a broader effort on tax reform, which, given the complexity of the tax code in the U.S., will take time, he said.
Looking longer-term, Hayes wonders if Washington really can reach a compromise on the tax code, given its complexity and considering how difficult it’s been to do much of anything in a bipartisan spirit. The tax treatment issue becomes very complex at a time when the United States particularly needs more infrastructure and borrowing costs may rise.
“That takes a very intricate knowledge and a real deep dive into the muni market in order to make informed decisions on all those things. And I just don’t think that Washington has the depth or the breadth to do that,” he said. “It’s probably a much longer-term issue.”
That means the threat is going to linger as long as the issue remains unresolved — and subsequently market uncertainty surrounding the status of the tax exemption for munis will, as well.
But investors lately appear to have been reacting to other market indicators.
“The average investor in the market, in general — and recent performance is evidence of this — is really not paying attention to this threat; they’re largely dismissing it,” Hayes said. “So, you have to have something far more concrete for the market to begin pricing that in. And we’re just not there yet.”
Meanwhile, other sources of volatility loom. The debt ceiling issue, for example, brings up some legitimate questions. To begin with, what happens to the U.S. rating? And, if the federal government is downgraded, what does that mean for rates in general? Rates could fall in a flight-to-quality bid. Or rates could rise because people lose faith in the U.S. government.
The debate is important, Hayes said, because it dictates the direction of other fixed-income markets, including munis. As it is, the debate in Washington will give the market a volatile tenor. But as munis have a tailwind from higher taxes, they should also be insulated by strong demand.
“I was just getting started in the business when we had the last big tax-reform scare: in 1985, prior to the tax reform act of 1986,” Hayes said. “I remember being on a trading desk in Boston … I remember the threats to tax exemption. It’s real. It can have a huge impact on the market.”
Hayes’ path to munis was a relatively straight one. He studied economics at the College of Holy Cross, in Worcester, Mass. After graduation, he quickly developed an interest in how the macro economy and interest rates affected the markets.
Hayes got into municipal bonds in the early 1980s while at BBS Inc. in Livingston, N.J., mostly a fixed-income shop that was active in muni bonds. There, he decided to move over to the portfolio desk, where he did tax swaps and looked to do portfolio reviews and tax efficiencies in individual portfolios.
“One of my first mentors was somebody at BBS who was very analytical, took the time to teach me, and his background actually was in municipal bonds,” Hayes said. “That was my first step into the market.”
