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Wednesday, November 24, 2010

More Signs of Dumb Money This Time in Muni Bonds ?

Sure looks like retail muni bond investors have gotten whipsawed big time in their muni bond investments. This is particularly costly in the volatile and illiquid muni bond market where selling into a panic is particularly costly. In fact if investors were selling out individual bonds or positions in open end mutual funds they might not have seen the full cost of their panicked selling as they didn't see the spreads they faced for their individual bonds or the pices used to calculate the net asset value at which their mutual fund sale was executed.

it. WSJ reports

Muni Tumult Ends Fund-Inflow Streak
The muni-market tumult upended a roughly three-month run of buying in long-term U.S. mutual funds.
Investors pulled an estimated $5 billion from long-term funds, the first week of net outflows, or selling, since late August, according to the Investment Company Institute.

The race for the exits was seen particularly in municipal-bond funds. Muni-bond values have slumped this month on a confluence of events, from surging Treasury yields to large new supply to the midterm election.....
A net $4.33 billion flowed out of bond funds in the week ended Nov. 17 after $3.96 billion was added the previous week, ICI said. Taxable funds had inflows of $457 million while municipal ones saw $4.78 billion in withdrawals.

Not mentioned in the article is probably the main cause for the muni bond selloff fears of a large supply coming into the bond market because of the end of the Build America bond program. The large increase in supply of conventional munis was expected to depress prices.
The fears appear to be unfounded as the wsj reports today

BAB Program Likely to Get Another Year

The Build American Bonds program, which provides federal subsidies for taxable bonds issued by state and local governments, is likely to survive another year, top Senate Republicans indicated.
The program is set to end on Dec. 31, and its possible expiration was one reason cited for the recent selloff in the municipal-bond market.
......Uncertainty about the program's fate helped lead to a glut in issuance that played a large part in roiling the muni-bond market over the past two weeks. A sharp selloff stabilized late last week, and muni-bond prices in the past few days have climbed slightly as issuance slowed ahead of the Thanksgiving holiday.

Those that sold off in the panic doubtless got burned particularly badly whether they held conventional muni bond funds, individual bonds, or muni bond etfs. The muni bond market is nortoriously illiquid has poor transparency. Retail investors attempting to liquidate small "odd lot" holdings in the panicky markets likely sold at very disadvantageous prices.

In the etf world much was made of the muni bond etf (MUB and others) trading at a "deep discount" to intrinsic value. While the low prices at which the MUB traded is not debatable I am a little skeptical that the "deep discount" to intrinsic value really existed. There are no real time prices for all of the bonds that make up the index so the etf price actually probably presented a better reflection of where munis were trading that the "intrinsic value' listed on data systems. After all if the intrinsic value represented a real world price the gap between the etf and the MUB would have narrowed massively through arbitrage. Here's a chart of the most widely traded muni bond etf (MUB) . Note the spike in volume at the time of the massive selloff...dumb money  panicking out ?

Those using alternative investment vehicles instead of the etf were unlikely to have made out better. Investors in closed end funds likely did worse as many of those funds traded at a discount to net asset value.

And the mere fact that there isn't intraday pricing for open end bond mutual funds and for "intrinsic value" doesnt mean that investors in those funds weren't burnt if they liquidated their fund in the panic.The investor in the open end mutual fund is really buying or selling a blind item. He never really knows how the bond prices are chosen that are used to calculate the net asset value fund . There is no single price source for the bonds and to the best of my knowledge there is no regulatory aurthoriity or other body that  requires a uniform methodology for this.

Here is the price chart of  the vanguard intermediate term tax exempt fund.(VWITX) Doesn't look much different than the MUB etf. So it doesnt strike me that the muni bond investor who chose an open end mutual fund vs and etf avoided the impact to he bond selling frenzy.

Looking at the sharp price selloff (and subsequent recovery) along with the fund flows it seems apparent to me that the latest example of retail investors late to the party buying high and selling low can be seen in the muni bond market.

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