SPDR® Nuveen Municipal Bond ETF [MBND] – Q4 2022 Commentary
MBND returned 3.58% for the quarter. Sector allocation was the largest positive contributor to performance, and rating allocation and selection both slightly detracted from performance. Curve positioning was the largest detractor from performance.
Performance
For the quarter, MBND returned 3.58%, specifically, the curve flattened between 1 and 12 years during the fourth quarter as interest rates declined by -0.20% on bonds due in 1 year, and by -0.70% on bonds due in 12 years, but it steepened between 12 and 30 years as yields fell by -0.32% on bonds due in 26 to 30 years, according to the Refinitiv MMD scale of yields of general obligation bonds rated triple-A.1 On maturities of 5, 10 and 20 years, rates declined by -0.60%, -0.67%, and -0.36%, respectively.2 With duration shorter than the benchmark, positioning of the fund detracted from performance as the market saw a broader rally. Sector allocation was the largest contributor to performance, whereas rating allocation was a slight detractor. An overweight to bonds maturing in less than 2 years hurt performance throughout the quarter, as the market rallied in late October through mid-December. Selection provided a slight detraction from performance.
Fund Performance
Quarter in Review
The fourth quarter began with continued pain, but cooling inflation and less hawkish market expectations led to strong performance in November and net positive performance for the quarter despite significant tax-loss selling. Credit fundamentals remain strong and municipal bond valuations are attractive, especially for Municipal-to-Treasury ratios beyond 10 years in maturity.
Municipal-to-Treasury yield ratios fluctuated, but remained much higher than the beginning of the year and historical averages. The 10-year ratio started the year at 67%, rose to its high of 105% on May 20th and then fell all the way back down to 68% to close the year.3 The 30-year ratio, which is typically cheaper, rose from 78% to a high of 110%, then ended the year at 90%.4
Supply continued to decline in the fourth quarter and ended the year 21% lower than in 2021 primarily because refundings fell by 52%. Outflows continued in the quarter, however at a slower rate than earlier in the year, and the combination of positive inflation data, low supply, and slower outflows generated strong municipal performance.
Portfolio Positioning and Outlook
The fund’s duration positioning relative to the benchmark hurt performance during the quarter, as an overweight to bonds with maturities less than two years and an underweight in bonds maturing in 12 to 17 years caused the majority of underperformance. Despite the market changing direction during the quarter, we still are cautious of potential volatility as the market expectations have shifted towards more accommodative Federal Reserve (Fed) policy, whereas the Fed has expected to maintain rates higher for longer. However, the intermediate and longer part of the curve provides more relative value so we will continue to look for opportunity across the curve.
An underweight in bonds rated AAA and overweight in unrated bonds hurt performance during the quarter. This was mostly offset by an overweight to bonds rated BB. MBND benefited from an overweight to hospital bonds, as well as an underweight to industrial development bonds, water & sewer bonds, and leasing bonds. An overweight to transportation bonds hurt performance.
A more balanced interest rate picture fueled the municipal market rally during the fourth quarter. The positive returns are even more impressive considering accelerating fund outflows. This resilience in the face of a volatile macro environment and Fed tightening offers several reasons for optimism in 2023. Municipal returns have historically bounced back strongly the year after a negative year. This trend has tended to correlate with fund flows which, when they reverse, may strengthen a market recovery. While economic and Fed policy uncertainty will likely lead to more Treasury rate volatility in 2023, municipals now have much higher yields as a cushion. Traditional municipal bond factors took a back seat to Fed policy in 2022, but these elements currently look favorable overall. Stable tax policy highlights the value of the tax exemption. And low tax-exempt bond supply and strong credit fundamentals position the asset class well for a possible recession. We believe a less active Fed should pave the way for these municipal factors to create a market recovery this year.