The appeal of US Taxable Muni Bonds: Q&A with Eaton Vance's Cynthia Clemson

I have been in US municipals my whole career, and have seen major changes in the asset class over the past 30-plus years. I was initially drawn to municipals because their analysis was interesting to me as it included more than just financial analysis - encompassing political, demographic and local economic analysis too.

Eaton Vance has been managing US muni investments for 38 years, making us one of the longest tenured firms in the US muni market. We manage US$35 billion in municipal bond strategies (as at 31 December 2016) and have one of the largest and deepest US municipal teams in the industry. We offer strategies that span the entire yield curve and credit spectrum.

We believe so. Many Australian institutions play a very active role in infrastructure investment but their exposures often have a home bias. Taxable US municipal bonds, although a relatively unknown asset class in Australia, offer access to US-based infrastructure debt in a liquid and transparent way. Investment in this asset class can both broaden and geographically balance Aussie instos' existing infrastructure exposures.

Looking ahead, we expect US taxable municipal supply will continue to represent a growing portion on the overall US municipal market, particularly with infrastructure being a political agenda item. On the demand side, we see steady and growing demand for taxable municipals as investors seek to diversify credit risk. Foreign ownership of taxable US municipal securities continues to be on an upward trend.

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Although the tax-exemption on interest from tax-exempt municipal bonds is a very valuable feature for taxable US investors, for investors not subject to US income tax the exemption has no value. Indeed, for most non-US investors, the lower nominal yields on tax-exempt municipal bonds detract from their appeal.

For most non-US investors, taxable US municipal (muni) bonds are a more appealing proposition.

The sector offers:
* An attractive total return track record;
* Yields which are typically competitive with US corporate and government debt;
* Higher credit quality compared with many regular investment grade corporate bonds, but with competitive interest rates and lower default rates;
* A unique, solid source of fixed-income credit diversification in portfolios largely allocated to corporate and government issuers; and
* Participation in one of the oldest and most well-established markets in the United States.

Taxable US muni debt is issued in all 50 states. It is used to fund the same kinds of essential public-purpose projects as their tax-exempt counterpart: bridges, toll roads, water and sewer projects, airports, electric utilities, hospitals and schools. Since most issues are backed by the taxing authority of state and local governments or dedicated revenue, the taxable sector shares the same low default characteristics of the tax-exempt sector.

Today, the outstanding volume of US taxable muni debt amounts to US$450 billion (as at 31 December 2016) - not far behind other major US debt sectors like high-yield bonds and floating-rate loans. The sector also has a large, diverse base of more than 10,000 issuers; far greater than that of US corporate taxable debt sectors like high-yield bonds and floating-rate loans.

We follow an actively managed, income-oriented approach which seeks to take advantage of relative value opportunities identified through fundamental credit research and technical analysis. Our research-based process incorporates qualitative and quantitative overlays, and is team oriented. In our view, the potential rewards of undertaking thorough fundamental research across the entire investable universe have become more evident since the advent of the global financial crisis (GFC).

Since the GFC, the landscape for trading and investing in the market has become more challenging even though the credit fundamentals of municipal bond issuers have remained strong. Regulatory changes have led to a loss of proprietary trading desks, broker-dealers have consolidated and this has reduced liquidity for some issues. Further, bond insurers have lost their Aaa ratings, so the credit quality of many more issuers have had to stand alone, without the benefit of an insurer's rating support. As a result, municipal bonds now trade less like commodities and more on their individual underlying fundamentals. Thorough research is rewarded by the market.

...and a little about you Cynthia:

As an International Relations and Economics major, I was always interested in how finance and development interact. I decided to pursue a career that would let me explore that relationship.

Be flexible and embrace change! It will happen with you or without you.

I am actively involved with a group called School the World, which raises money to build schools and fund sustainable education in rural Guatemala. I have travelled to Guatemala with groups of high school students to help build schools and to immerse the students in a different culture. I believe that all children should have access to education, and my goal is to help provide education for a population that has little chance of gaining education without programmes such as School the World.