Investment Grade (barely)

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workerbeeengineer
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Investment Grade (barely)

Post by workerbeeengineer » Sun Jan 14, 2018 4:11 pm

Fellow BHs...I was doing a little general research on municipal bonds and funds. Observed that Fidelity offers a Fed Tax-free bond fund (FTABX). Indicated strategy is at least 80% in investment grade municipal securities. Here's what I find interesting - as of Dec 31 the largest state for holdings is Illinois at 17.9%. I'm pretty sure Illinois has the lowest credit ratings from the 3 big debt rating agencies. From 5 minutes on the Internet, my impression is it's basically one rating level above junk. In addition. 3 of the top 5 holdings in the fund are Illinois issued. I looked for a comparison and believe I found a reasonable one in Blackrock National Municipal Fund (various share classes, one is MCNLX). Illinois composes a more modest 9.26% of that fund's holdings. Stated strategy is no more than 35% invested in below investment grade, but no Illinois holdings in MCNLX fund top 10. If one views Illinois securities as border-line junk, then that state essentially "consumes" the entire non-investment grade 20% allocation in FTABX. The fund prospectus indicates one of the principal fund risks is Issuer Specific Changes:

The value of an individual security or particular type of security can be more volatile than, and can perform differently from, the market as a whole. A decline in the credit quality of an issuer or a provider of credit support or a maturity-shortening structure for a security can cause the price of a security to decrease.

But I don't spot any discussion on basic single state concentration as a risk. The Fido fund ER is admittedly much lower than Blackrock ERs and I'll also acknowledge it's likely that at least some of the Blackrock share classes carry loads. So sure, the Fido fund is lower cost. Additionally, I'm sure that Illinois has to pay higher interest than other states if it wants anyone to take on it's risky debt and that's why Fidelity, Blackrock, and everyone else has it in their portfolios. But overall, is the Fidelity fund really holding to it's stated strategy? IMO...not really. I'd also say that the risk profile is not well communicated. Other opinions or comments???

dbr
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Re: Investment Grade (barely)

Post by dbr » Mon Jan 15, 2018 12:23 pm

workerbeeengineer wrote:
Sun Jan 14, 2018 4:11 pm

But I don't spot any discussion on basic single state concentration as a risk.
My recollection is that it has been an almost obligatory comment that single state risk is a factor that must be considered. It really comes down to what fraction of one's wealth is involved. If muni bonds are 5% of your assets concentrating that in one state is hardly an issue. If, for example, half your assets are in munis, it might make sense to keep a lot of that in a more diverse national fund even if one does not get the state exemption. Maybe people have just not been mentioning the consideration in one or another particular thread.

Theoretical
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Re: Investment Grade (barely)

Post by Theoretical » Mon Jan 15, 2018 3:22 pm

In this era of stretching for yield I think this is a HUGE consideration. I've read dozens of muni bond prospecti and annual reports, both index and active, and what I've seen is that the indexes are naturally loading up on the bloated, dubious pigs like Illinois, New Jersey and the like, BUT SO ARE THE ACTIVES. Also, the actives play around a lot more in the A to BBB turf, with very few exceptions.

There are states in dramatically better fiscal shape, but you don't see even "conservative funds" loading up on them, partly due to capacity and because the bonds would be taxable to large groups of the population.

You can build a bundle of moderate cost muni funds for about 50-60 bps total using Fidelity and Ameritrade.

TomCat96
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Re: Investment Grade (barely)

Post by TomCat96 » Mon Jan 15, 2018 3:52 pm

This is exactly why Im 100% stocks and unapologetic about it. There is nothing new about this. It is in the inherent nature of profit seeking to reach unduly for yield. When the only thing holding one back from reaching for yield is a risk analysis and self discipline, I think it inevitable for such a barrier to erode in the good times with careers on the line.

Geologist
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Re: Investment Grade (barely)

Post by Geologist » Mon Jan 15, 2018 4:04 pm

I think you need to be careful when you say that this Fidelity has 17.9% in Illinois municipal bonds as if all Illinois muni bonds are the same. Now I don't know exactly what this fund holds since I only have Vanguard funds, but Vanguard funds have a whole host of issuers in every state including Illinois. For Illinois, most of the issues in Vanguard funds are not state GO. Many are revenue bonds (O'Hare and Midway Airports, for example), some are from local school districts, or are issued on behalf of hospitals or private universities (such as the University of Chicago). So your supposition that all these bonds are "just barely investment grade" is unlikely to be correct.

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Ethelred
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Re: Investment Grade (barely)

Post by Ethelred » Mon Jan 15, 2018 4:34 pm

It's probably noting that VWITX (Vanguard Intermediate-Term Tax-Exempt Fund - Investor Class) is (one of?) the largest muni funds. As of the latest annual report in October, it contains this as the top ten:

New York 16.2%
California 12.3
Texas 9.4
Illinois 6.4
Florida 4.9
Pennsylvania 4.7
Maryland 3.6
Michigan 3.1
New Jersey 3.1
Massachusetts 2.8
Top Ten 66.5%

Maybe it has too much in New York and California? I don't know. But does this look better than a lot in Illinois?

Theoretical
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Re: Investment Grade (barely)

Post by Theoretical » Mon Jan 15, 2018 5:12 pm

TomCat96 wrote:
Mon Jan 15, 2018 3:52 pm
This is exactly why Im 100% stocks and unapologetic about it. There is nothing new about this. It is in the inherent nature of profit seeking to reach unduly for yield. When the only thing holding one back from reaching for yield is a risk analysis and self discipline, I think it inevitable for such a barrier to erode in the good times with careers on the line.
This highlights one of the biggest problems of active management in general, which is that normal bond funds reach for yield at the expense of equity diversification and stock funds have "safety valve" "defensive" positions allowed in the prospectus but both are done in a discretionary way that too often equals "what the investors' emotions want."

It's just incredibly hard for them to let bonds be bonds and stocks be stocks.

Even the "safe" state funds like those for North Carolina or Nebraska likely reach for yield in various ways like picking up weaker credits instead of sewer, road, and school bonds that are boring (low yield) but very safe.

workerbeeengineer
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Re: Investment Grade (barely)

Post by workerbeeengineer » Mon Jan 15, 2018 11:37 pm

Geologist wrote:
Mon Jan 15, 2018 4:04 pm
I think you need to be careful when you say that this Fidelity has 17.9% in Illinois municipal bonds as if all Illinois muni bonds are the same. Now I don't know exactly what this fund holds since I only have Vanguard funds, but Vanguard funds have a whole host of issuers in every state including Illinois. For Illinois, most of the issues in Vanguard funds are not state GO. Many are revenue bonds (O'Hare and Midway Airports, for example), some are from local school districts, or are issued on behalf of hospitals or private universities (such as the University of Chicago). So your supposition that all these bonds are "just barely investment grade" is unlikely to be correct.
Geologist, point taken. I certainly did not do any security by security analysis of the Illinois holdings of the Fidelity fund. However, I would stand by my basic view that loading up on that state's securities is somewhat disingenuous. I would also think the low credit ratings assigned by the credit rating organizations are based on some weighting or formulation that takes into account the points you raise. Any bond rating experts out there?

Theoretical
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Re: Investment Grade (barely)

Post by Theoretical » Tue Jan 16, 2018 9:32 am

Well, the other problem is that many of the Illinois and New Jersey issues are "AAA," but the underlying structure is publicly and obviously rotten.

With the non-Chicago issues, the problem will be with anything that's GO. I'd still be cautious but would be slightly more comfortable with basic municipal infrastructure type bonds (school, utility, road).

pkcrafter
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Re: Investment Grade (barely)

Post by pkcrafter » Tue Jan 16, 2018 11:28 am

TomCat96 wrote:
Mon Jan 15, 2018 3:52 pm
This is exactly why Im 100% stocks and unapologetic about it. There is nothing new about this. It is in the inherent nature of profit seeking to reach unduly for yield. When the only thing holding one back from reaching for yield is a risk analysis and self discipline, I think it inevitable for such a barrier to erode in the good times with careers on the line.
So, you stick with all stock because bonds are just too risky. :happy


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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