November 2012 Market Commentary
Clinton Investment Management
By Andrew Clinton
November 15, 2012
On a year-to-date basis, the municipal bond market continued to perform well both on an absolute and relative basis, further demonstrating why investors have embraced tax-free bonds and have allocated significant portions of their portfolios to the asset class. We, at Clinton Investment Management (CIM), are truly grateful that our clients have enjoyed strong returns on a relative basis. Inception-to-date, our market duration strategy has outperformed over 90% of the over 100 municipal bond managers that make up the PSN/Informa Universe. Our composite returns are ranked in the top quartile if not the top decile of the universe on a quarter-to-date, year-to-date, one year, two year, three year, four year, and five year basis (Fig 1).
Figure 1. PSN Comparison
We firmly believe these results further demonstrate the value we add on behalf of our clients. While it is hard to believe that over five years have past since founding CIM, we are very proud of the results we have achieved for our clients. Our business has grown considerably in the past nine months due, in large part, to the strong relationships we have built with our existing clients and their willingness to share their experiences with their family, friends, and colleagues. CIM now manages over $260 million and our firm assets under management have increased by over 30% year-to- date. As a boutique firm specializing in municipal bond management, we are truly grateful for our client’s ongoing loyalty and confidence as their satisfaction and willingness to refer others is the primary means by which we seek to grow both now and in the future.
In light of the approaching fiscal cliff and likely changes to the US tax code, we continue to believe that municipal bonds offer some of the most attractive risk- adjusted return potential available in the market today. Figure 2. clearly illustrates the risk-adjusted, taxable equivalent returns of various asset classes over the past decade. The very high standard deviation of returns of the S&P 500, Dow Jones Industrial Average, NASDAQ, and Russell 2000 indices, at 15%, 14%, 18% and 20% respectively, are particularly noteworthy given the low return these indices have delivered per unit of risk. On the contrary, over the past ten years, tax- exempt municipal bonds have delivered some of the highest risk-adjusted, taxable equivalent returns. Given this data, it raises a question as to why investors haven’t owned more municipal bonds as a percentage of their overall asset allocation over time. This may be due, in part, to the fact that investors, when optimizing their asset allocation, may fail to account for the standard deviations, or associated risks, of various investments, while neglecting to appropriately quantify the taxable equivalent return on municipal bonds. Investor return expectations may also fail to account for the very real negative impact that a dramatic rise in both state and federal income taxes can have on their taxable investments in the future.
While the possibility remains that municipal bond tax exemption could fall under the knife of fiscal austerity, the reality is that doing so could materially diminish the value of municipal bonds in the eyes of taxable investors. A subsequent decline in demand would likely translate into significantly higher borrowing costs for any municipality needing to fund operations through the capital markets. Given that there are over 50,000 municipalities across the country, the unilateral revocation of all or part of the tax exemption of municipal bonds would not only be highly unpopular, but would also have wide reaching negative consequences for millions of tax-payers and bond holders. This fact, I am sure, will not be lost on officials seeking re-election in the future. While we continue to monitor the situation closely, we continue to believe that the tax- exemption of municipal bonds will remain intact.
Figure 2. Risk-Adjusted Taxable Equivalent Return Ten Years Ending 10/31/12
From an investment perspective, we have begun to see signs of broader credit stabilization in the municipal bond market. Due to the substantially higher relative yields associated with lower AA and A rated municipal bonds, we have begun overweighting select issuers where we see credit improvement together with higher return potential. We believe far too many managers and investors wait for credit rating agencies to actually upgrade issuers before recognizing fundamental credit improvement. This provides active mangers, such as ourselves, the opportunity to buy bonds, on behalf of our clients, that offer higher yield for lower relative credit risk.
As we approach year-end, we are monitoring the Fiscal Cliff debate between Congress and the President very carefully. We believe that there is a very real possibility that a compromise could be reached that would allow the deadline for the expiration of the Bush tax cuts, payroll taxes increase, and the budget cuts arising from sequestration to be extended. Given the political gridlock that has persisted in Washington for some time, however, there exists the very real possibility that we could go over the Cliff. In either case, we believe clients would be well served to seek out the safety of tax-free bonds as we expect the prospects for meaningfully higher federal tax rates, low inflation, and the potential for slow to negative economic growth rates, both in the US and the global economy, to persist for an extended period.
Please feel free to contact us directly if you should have any questions regarding this commentary, the municipal bond market in general, or our investment strategies in particular.
Important Disclosure Information
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Clinton Investment Management, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. A copy of our current written disclosure statement discussing our advisory services and fees is available for review upon request.
*ITD - 05/31/2007 through 9/30/2012
**Criteria: The PSN universes were created using the information collected through the PSN investment manager questionnaire and use only gross-of-fee returns. The PSN/Informa content is intended for use by qualified investment professionals. Please consult with an investment professional before making any investment using content or implied content from any investment manager.
***The following data more fully explains and reflects the impact on the performance results if the maximum Clinton Investment Management fee was applied over the corresponding time periods, QTD 2.41%, YTD 5.83%, 1 YR 7.89,% 2 YR 5.14%, 3 YR 5.06%, 4 YR 7.80%, 5 YR 6.02%, ITD 6.18%.
(c) Clinton Investment Management