Thornburg’s View of the Corporate and Municipal Bond Markets

The Thornburg Strategic Income Fund (TSIAX) has returned 5.87% over the last five years (the longest period for which Morningstar provides data), outperforming the Barclay’s AGG benchmark by 277 basis points. The Thornburg Limited-Term Muni Fund (LTMFX) has returned 3.16% over the last 15 years (the longest period for which Morningstar provides data), versus 2.46% for its Morningstar peer group, placing it in the 18th percentile of that group. I spoke with Lon Erickson and Christopher Ryon who are respectively managers of those funds.

Christopher Ryon, CFA, is a portfolio manager and managing director of Thornburg Investment Management. He joined Thornburg as associate portfolio manager in 2008 and was named portfolio manager in 2009.

Chris holds a BS from Villanova University, an MBA from Drexel University, and is a CFA charterholder. Chris has 25 years of experience in the investment management field. Before joining Thornburg Investment Management, he served as head of the long municipal bond group for Vanguard Funds, where he oversaw the management of more than $45 billion in 12 intermediate- and long-term municipal bond funds.

In 2013, Chris was selected as a member of the Municipal Securities Rulemaking Board’s (MSRB) board of directors.

Lon Erickson, CFA, is a portfolio manager and managing director for Thornburg Investment Management. He joined Thornburg in 2008 and was made portfolio manager and managing director in 2010.

Lon earned a BA in business administration with a minor in economics from Illinois Wesleyan University and an MBA from the University of Chicago's Graduate School of Business. He is a CFA charterholder. Prior to joining Thornburg Investment Management, Lon spent almost 11 years as an analyst for State Farm Insurance in the equity and corporate bond departments.

I spoke to Chris and Lon on October 5.

I’d like to begin by getting your views of the overall macro landscape and, in particular, how that is bearing on the U.S. bond market. In your last commentary, you cited a number of macro risks – uncertainty over the path the U.K. will take with respect to Brexit, the weakness in the Chinese renminbi, the U.S. political divide, instability in the Italian banking system and now with Deutsche Bank, to name a few. You posed the rhetorical question, “Given all of the challenges mentioned, why are we today facing the lowest yields in the history of bond investing?” How do you answer that question?

Lon: We look around the world and we see a lot of weak, slow growth but not a recession. We see that in all sorts of economic activity data. We see that in the levels of inflation around the world. We see that in corporate earnings.

There's only been two significant bright spots for the world economy. China kept their economy chugging along even at a slower but still meaningful rate of say 5% or 6%. The U.S. consumer and China have been the two main drivers of overall economic activity, and even so it's been pretty low.

What has made the markets go around and has really impacted the U.S. bond market has been the central banks: the Bank of Japan, the ECB, the Bank of England and the Federal Reserve flooding the markets with liquidity. That has led to a scramble for yield as they took the yield out of the risk-free curves. Around the world, as people looked along the yield curve, they went further out in duration, and further down the credit spectrum as they were trying to increase the income that they could earn. That hasn’t been confined to the bond markets. That’s extended into all risk-asset classes. Clearly, equities have benefited from that flow of liquidity.

One of the major risks to this scenario has been if the Fed, the ECB or whoever pulls back. We had a taper tantrum back in May 2013, and that was just from the Fed saying that they were going to stop its quantitative-easing purchases. They weren’t pulling it back. They weren’t selling securities. They were just going to stop purchasing new ones, and we saw what that did. So if all the central-banks did this together at the same time we could have a major pullback in rates.

Why are we seeing the lowest yields? Why haven’t any of these global political economic credit events resulted in higher yields? It is because the central banks have credibility in the marketplace that if there is a disruption they’ll be there with additional liquidity to bandage over any wounds.

Chris: Markets swing much like a pendulum does. When you look at the value metrics in much of the fixed income markets right now, they have all swung to one end and are pricing the best possible outcome into the future. For example, let’s take a 10-year treasury. The 10-year Treasury bond is yielding 1.70%. The last core PCE inflation read was 1.70%, so you're not earning anything over inflation. You have a real yield of zero. Over the last 15 to 20 years, investors typically earned 2% over inflation.

You see the same thing in terms of credit spreads¸ which are extremely narrow. In that context, investors are getting security covenants that are extremely issuer-friendly, not investor-friendly.

Christopher Ryon, CFA
Lon Erickson, CFA