A deep dive with T. Rowe Price portfolio manager Hugh McGuirk
I had a chat with Hugh D. McGuirk, head of T. Rowe Price’s municipal bond team and a member of their Fixed Income Steering Committee. Mr. McGuirk is also a portfolio manager for the US Municipal Long-Term Bond Strategy at T. Rowe Price. Here is the interview.
Q: Do you do credit analysis in house?
A: Hugh McGuirk: Yes. The T. Rowe Price municipal investment strategy is driven by rigorous, independent fundamental analysis.
Q: Are you finding adequate dealer liquidity when you need to make adjustments to portfolios or cover redemptions?
A: In the wake of the financial crisis and in the face of more stringent regulations, dealers have scaled back their inventories significantly. We believe this trend is one that is likely to persist. While this generally reduces liquidity across the municipal markets and can amplify volatility, particularly during sell offs, we are able to trade efficiently and effectively in the municipal market.
Q: Is shrinking municipal bond issuance a problem for you? Would it be if inflows got stronger?
A: We have not found the lower level of municipal bond issuance during the past several years to represent a problem for our approximately $19 billion dedicated municipal bond platform. We view the level of muted issuance as a natural by-product of deleveraging in the U.S. economy since 2008, along with fiscal austerity, not only at the federal level, but also at the state and local levels.
Stronger inflows could impact our approach of remaining fully invested across a full market cycle. In recognizing that we may not get the primary issuance that we want―in conjunction with stronger flows that may come within a concentrated segment of time―we may need to purchase certain liquid and benchmark representative issues tactically to gain market exposure and then methodically shift our exposure into the securities we prefer over time.
Q: Do you use interest rate swaps in your portfolios?
A: No, we generally do not in our municipal portfolios. We are a traditional cash bond manager.
Q: What is your view on Puerto Rico? Are some credits more attractive (for example, COFINA)? Do you own any Puerto Rico bonds?
A: We have been bearish on debt issued by the Commonwealth of Puerto Rico for the past several years. It became evident that the Commonwealth’s structural deficit was not going away and that they would eventually have difficulty sourcing funds in the bond market.
As such, we do not own any of the Commonwealth’s GO debt, which we view as being most at risk given the island’s significant fiscal, macroeconomic, and headline challenges. Outside of the GO, we have a minimal allocation to Puerto Rico and have generally preferred to gain our modest exposure to the Commonwealth’s increasingly high yields through sources that offer dedicated revenue streams, such as COFINA.
Q: What about Illinois and Chicago?
A: As a platform, we have historically avoided Illinois and Chicago GOs, as valuations have not been compelling enough to offset fundamental weakness (fiscal duress and a noteworthy level of underfunding in their respective pensions) in both of these municipalities. While we remain cautious about their fiscal outlook, we will invest in certain revenue sector credits located in these areas that offer attractive valuation and are also insulated from the pension risk that exists within Illinois at both the state and city of Chicago levels.
Q: Do you have any thoughts on Congress capping the muni tax exemption?
A: As 2013 opened, we acknowledged an elevated risk of change to the traditional tax exemption on muni bond income. From our perspective, once sequestration actually went into effect (without a political compromise that impacted the traditional muni income tax exemption), the risk of a change lessened considerably. We do not expect a change to the muni tax exemption in 2014.
Q: Why does interdealer trading constitute such a large part of daily trading?
A: Significant dealer activity is a natural consequence of the fragmented, highly diverse, and retail- dominated municipal bond market. For example, many of the bonds traded in the municipal market are issued by local municipalities that may not generate interest from investors in outside states. As such, local expertise in these bonds, in the form of specific dealers, would be required to help these local issuers come to market and to ensure that a secondary market exists for the bonds. The latter point represents a singular example of dealer involvement, but from an overall market perspective the key point is that a highly diverse market demands a meaningful level of dealer expertise and involvement.
Q: If trading is volatile, like Puerto Rico bonds were in September, does the muni market have the proper infrastructure to signal market levels?
A: We believe that price discovery in the municipal bond market is markedly improved from where we were a decade ago. The MSRB’s EMMA, for example, makes available muni trade execution data that has helped level the playing field for all market participants.
Even with developments such as EMMA, amidst periods of significant volatility, price discovery inefficiencies can exist within the municipal bond market. We believe the regulator’s efforts to improve transparency and ongoing disclosure are valuable initiatives to support a more efficient market.
Q: Do you have any thoughts on the MSRB’s proposed Central Transparency Platform that would include pre-trade information? Would it be useful for your team?
A: The MSRB’s Central Transparency Platform is an additional effort to improve transparency in our market. Any system that improves transparency in what remains a truly diverse market is a positive step for improving best execution on trades. We applaud and support the MSRB’s efforts to improve transparency for all investors, both pre-trade and post-trade.
Q: Hector Negroni of Fundamental Advisors said that hedge funds and other crossover buyers could add significant liquidity to muniland. Any thoughts?
A: The expansion of the buyer base in the market certainly provides an opportunity to improve liquidity conditions. With that said, we remain cautious about the sustainability of non-traditional investment in the market. While non-traditional buyers provide an extra layer of liquidity, they also perhaps represent the first investors who would exit the market should conditions change. However, to the extent that they provide a sustainable bid, we believe inclusion of non-traditional buyers is encouraging for municipal investment. Perhaps more importantly, the addition of new buyers enhances market efficiency and information as well.
Q: Do you have a view on interest rates next year?
A: We believe interest rates are likely shifting from being technically and QE-driven to being driven by fundamentals and the long-term growth trajectory of domestic GDP. As such, we expect that rates will continue to normalize, which is to say that they will rise. However, given the significant adjustment that has already occurred in the Treasury market (as well as in the municipal market) we believe that rates have already priced in the tapering of Fed asset purchases to a certain degree. Further rate increases will likely be less substantial than those experienced in 2013 and should occur at a more modest pace in our view.