SPDR® Nuveen Municipal Bond ETF [MBND] – Q1 2021 Commentary
MBND launched in February with an initial seed of $30 million. Since its launch, the fund has experienced the creation of an additional 300,000 shares bringing the total market value of the fund to nearly $39 million at the close of the quarter.
Municipal relative strength versus the US Treasury market broke during February. US Treasury yields, which have been trending higher for much of the New Year, had not filtered over to the municipal market until the latter weeks of February in anticipation of a heavy new issue calendar. The market successfully digested a supply uptick and regained its relative strength in March. For the quarter, municipal rates rose by 21 to 36 basis points for most of the curve 5 to 30 years. The shortest portion of the curve has been anchored by Federal Reserve policy, leaving yields within 2 years largely unchanged. This action produced a much steeper curve, going from 123 to 161 basis points between 2s and 30s.1
Municipal credit performed well over the course of the quarter. The yield on the high yield index dropped from 3.82% to 3.64%, tightening credit spreads by over 50 basis points for the quarter.2 Ratios of municipal yields to US Treasury yields have experienced extremes over the past year, moving from historically cheap to historically rich. The extreme richness achieved by mid-February could not hold and municipals succumbed to selling pressure late in February as the new issue calendar built. Municipals underperformed briefly but regained their footing in March. New issue supply totaled $102.6 billion putting the market on pace with last year’s total.3
Quarter in Review Fixed income returns were broadly negative in the first quarter. The culprits: rising long-term interest rates and fears of higher inflation, driven by accelerating COVID-19 vaccinations, robust economic growth, new fiscal stimulus and a Federal Reserve firmly committed to maintaining easy monetary policy.
The bellwether 10-year U.S. Treasury yield jumped 81 bps during the period, from 0.93% to 1.74%. With the Fed anchoring short-term rates, the yield curve steepened significantly. Against this backdrop, the Bloomberg Barclays U.S. Aggregate Bond Index returned -3.37% — its worst quarterly result on record. Municipals fared much better as measured by the Bloomberg Barclays Municipal Bond Index at -0.35% and a strong showing from Bloomberg Barclays Municipal High Yield Index returning 2.11%.4
The first quarter’s bond market sell-off reflected stronger global growth, upward pressure on yields and prospects for hotter inflation. Looking ahead, we think these themes will persist, and we continue to prefer high yield and lower investment grade over longer-duration and higher-quality segments.
Portfolio Positioning and Outlook The portfolio has been in accumulation phase since inception. At quarter end, the seed capital has been fully deployed and we have experienced additional capital contributions. The portfolio holds 16% in its BBB and below quality buckets. We expect to continue to build this toward its 20% maximum during the second quarter. We are focused upon individual securities that we deem to be attractive over targeting specific sector over/under weightings at this point. We do however favor revenue bonds over general obligation bonds, which typically can provide a yield advantage. At quarter-end, the portfolio held overweights to the Education, Industrial Development, Leasing, Special Tax and Transportation sectors. In addition to being underweight General Obligation bonds, we also carry underweights in the Healthcare, Power and Water & Sewer sectors. The portfolio is roughly one year long relative to its benchmark duration. Here again, duration is an output as we build and assemble bonds into the portfolio. We are sourcing new purchases primarily from the new issue market and on the longer end of our maturity range.
As an example, we are seeing upticks in supply from New York credits. New York accounted for four of the seven largest transactions this quarter. The portfolio participated in three of these transactions. New York paper is abundant currently but spreads should narrow as supply dries up going into the summer. We added below investment grade names from the primary market as well this quarter. Among these credits were US Steel, Detroit, Chicago Board Of Education, Guam Hotel Occupancy Tax and California Housing Projects. We continue to look for these opportunities as our best source of alpha in the portfolio over the weeks ahead. High yield issuance remains extremely light and we plan to patiently add to this portion of the portfolio going forward.
Finally, we look to sell securities opportunistically into strong bids. During the period, we sold four securities, purchased at new issue that experienced spread compression to capture total return performance. Albeit the portfolio is relatively new and it will take some time for our trade ideas to bear fruit and be able to capitalize on them via active management.
1 Thomson Reuters Municipal Market Data, as of March 31, 2021. 2 Blomberg, Barclays Bloomberg High Yield Municipal Index data as of March 31, 2021. 3 The Bond Buyer (new issue supply data), as of March 31, 2021. 4 Treasury.gov, as of March 31, 2021.
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