Municipal Bonds: Volatility Yields Opportunity

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GREG HALL: Hey, everybody! Welcome to Accrued Interest PIMCO's podcast dedicated to serving financial advisors and their clients. My name's Greg Hall. I head Wealth Management for PIMCO in the United States. I'm your host today, really excited to bring you this edition of Accrued Interest, which is gonna focus on the municipal bond market.

This is something that we've been planning now for months, and the original idea was to bring you this episode right around tax day, because of course, municipal bonds are for the most part, tax exempt terrific way for a lot of advisors and their clients to invest in fixed income securities in a tax advantage way. And we did not know when we, you know, began planning for this episode, that it would actually, the recording would fall amidst some of not just the most extreme equity market volatility we've seen in a long time.

Some of the most extreme bond market volatility that we've seen in a long time, but also a really volatile period for the municipal bond market. So, this turns out to be an incredibly timely recording, and we hope that you'll find it really valuable as you and your clients think about your positioning within Munis or if you're considering a position within Munis we hope that this can be educational and give you some perspective on that. To that end our, our main guest today is Dave Hammer. Dave is our head of the Municipal Bonds here at PIMCO. He's a managing director with the firm. He's in our Newport Beach office. And he's with me here, live over the microphone. Dave, welcome to the podcast!

DAVE HAMMER: Hey, Greg! Thanks for having me!

GREG HALL: Pleasure to have you! And then as we always do, we've invited one of our account managers to join us, and she's gonna represent the views and the hopes and the dreams and the needs of advisors in her region. We've got Antonese Robertson, who covers Southern California and Las Vegas for us, Antonese, thank you for joining us!

ANTONESE ROBERTSON: So excited to be here!

GREG HALL: Not too far for you to get into the office from down there in Southern California, huh?

ANTONESE ROBERTSON: Not at all.

GREG HALL: All right, that's great! Well, this is good, Dave! I, we definitely want to get to the events of this past week. And, but I'm gonna delay gratification on that for just a minute because I want our listeners to really understand sort of who you are, the perspective that you're coming at them with here. So, if you don't mind, do you want to give us your life story and how you ended up at PIMCO?

DAVE HAMMER: I'd love to! So I grew up on the East Coast, and I've been here in Newport Beach for now about four and a half years. But, you know, mostly on the East Coast grownup and started in the Muni market back in 2003. I worked in, Purchase, New York for Morgan Stanley. They had a trade floor up there that they opened after 911, actually. They sold their building, they were planning to occupy to Lehman Brothers and moved up to Westchester County.

So I was up there and I started on the very, very front end of the Muni curve working on an institutional trading desk. And that included trading really short duration bonds where you can't get into too much trouble. I also did things like pricing commercial paper for mini issuers, pricing our VRDN book, which were sold to money market funds.

GREG HALL: VRDN

DAVE HAMMER: VRDNs, yeah.

GREG HALL: We're gonna stop you on every acronym, so you might as well explain it.

DAVE HAMMER: You're gonna have to stop me a lot.

Just getting started. Yeah, I did that for a number of years. And then as is kind of normal on the sell side, I began to move out the curve and trade riskier parts of the market. By the financial crisis, I was trading longer duration, high quality Muni bonds when the whole world came to a sudden stop. And, you know, I learned a heck of a lot that year. I remember when the auction rate market broke.

I recall when the Muni market had a severe period of de-leveraging tender option bond unwinds. And I helped run a lot of those programs at Morgan Stanley. They're still probably the most interesting year of my career. Learned a ton about markets, about the way people react in stressful times. And after the financial crisis, you know, the Muni market really changed. It used to be really more like a rates market. It was mostly monoline insured by mono lines that were triple-A rated. They all went away after the financial crisis.

GREG HALL: This is NBIA and back that group of insurance companies.

DAVE HAMMER: Yeah, exactly! NBIA and back. You know, a few of them still survive in different smaller forms. National Insurance is out there, but sure guarantee, but it's few and far between these days. So you know, got excited about that. And at Morgan Stanley put my hand up and said, Hey, I'd really like to build out a business that focuses on high yield and distressed Muni bonds, that there really wasn't much of a marketplace back then.

And they were kind enough to let me hire a couple credit analysts, start a new business there. You know, found myself investing in distressed tobacco bonds in Jefferson County, Alabama water and sewer system as they worked through bankruptcy. Had a lot of fun learning, you know, new things in that part of the market. And then eventually came to PIMCO in 2012.

I can't believe it's that long ago. But, you know, joined here to bring some of that experience. And when I came to PIMCO, you know, why did I come here? Well, you know, always viewed PIMCO as really, you know, really the smartest investors in active fixed income markets. And they really didn't have much of a Muni business. It wasn't a priority for PIMCO way back when. And, and so looked at, you know, the resources and the people at this firm and an opportunity in a Muni market where they didn't really have a footprint to try something a bit different.

GREG HALL: That's great! It's a, I think I'd known that about you, but I'd forgotten the level of experience you'd had in some of the tougher workout situations in Munis. And I think having that opportunistic lens on markets has gotta be a huge benefit to you  even if you're looking at things that you think are credit worthy, right? Just knowing how things can go wrong and what to do if they do happen to go wrong. I would imagine that's an advantage you've got. And also one that's probably been hard to recreate over the last 10 years without a lot of credit issues out there.

DAVE HAMMER: Yeah. I mean, you'd be surprised, you know, a million different 50,000 issuers. There's always unique credit problems. And the Muni market, I think people think state and local government debt, but a lot of what we invest in, it's, you know, revenue backed bonds, so backed by some sort of asset. It could be commercial real estate, residential real estate, commodities firms, power companies, corporations.

So yeah, we are constantly applying, you know, lessons that we've learned in many cases, the hard ways, over lots of years of investing to help keep us outta trouble, even in, you know, AA and A rated Muni bonds.

GREG HALL: What tell us a little bit about your team, your process, you know, kind of how you go about things on a day-to-day basis.

DAVE HAMMER: Yeah, so the team's grown a lot. When I joined PIMCO, we had just a handful of PMs and analysts, and today we have 10 portfolio managers just focused on Munis. We have a dozen credit analysts that are focused on either parts of the country or specific sectors that are a little bit more complex. Things like healthcare, public-private partnerships, things of that nature. And then we also are supported by the 85 plus analysts across the firm.

And they support our investment team really in two ways. One is contributing different ideas when we're underwriting assets. So you know, simple example, if we're looking at a healthcare issuer in the Muni space and trying to understand what are their wage expenses gonna look like, what are the reimbursement rates gonna be from commercial payers? We can go to our economics team on the wage side.

We can go to our for-profit healthcare analysts and gain some insights. We then also have a number of analysts that are directly covering credits that end up in our portfolio. So prepaid gas bonds, a big part of the Muni market today, that the underlying obligors are actually US financial institutions. So we have a finance analyst that cover those credits. You know, a lot of support from those analysts.

We then have a really big tech and analytics team north of 20 today that are either helping us find value and mispriced callable bonds, different unique sets of cash flows, or helping really change the way we execute, you know, more and more of the way we trade today, it's done electronically. We're using big data that we create ourselves and channeling into the market to try to both identify opportunities and then get there faster than others.

You know, as it pertains to process PIMCO's one investment process, we're just a part of it. And that's really important in the Muni space. In addition to benefiting from all these analysts that cover different parts of the globe and different types of assets. You know, we get a ton from our macro analysis,  our CIOs, our economics team helping us answer questions like, where are we in the credit cycle? What do we think the probability of recessions is?

Where could we find you know, problems just over the horizon in different sectors? And then, you know, today's a great example. Our policy analyst, our policy team led by Libby Cantrill, tremendously impactful on the way we think about tax policy risk, things that may or may not happen, things that may become headlines that might make retail investors a little bit more nervous, you know, constantly those inputs are helping make us, you know help us make, more informed positioning decisions.

GREG HALL: Yeah. I, we had Libby and Tiffany Wilding for listeners, our Heads of Public Policy and our senior US economists respectively. We did a recording with them a couple of days ago. You know, it was a quick rundown of some of the implications of Liberation Day. And we recorded it, of course, you know, a day before the pause was announced. We did a follow-up segment with Dan Ivascyn our group CIO that was a recording of a webcast he had done that I think finished like an hour before the pause was announced. And we're trying to get a lot of information out to our clients here and just have to sort of do it with the recognition that the world's moving quickly.

And so trying to supply them with, you know, frameworks for thinking about things and ways to interpret moves. But knowing that, you know, by the time the three of us are done here today, we might be in a different, you know in a different world depending on the news flow. It's been pretty wild. I and that's a great segue, actually, Dave.

You've had quite a week in your market, and I'm so appreciative that you're here with us. And maybe, you know, for folks listening, you know, do you want to just kind of talk through the enormity of what's gone on in Munis over the last few days and maybe what you think is in store and how you're reacting to it?

DAVE HAMMER: Yeah. It has been a heck of a week. I was shocked to learn. It's only Thursday,

Not over over yet. You know, so I think for the Muni market, it's important to start with initial conditions. So pre liberation day, the month of March was actually a pretty big sell off for the Muni market. Treasuries were firm and actually rallying for much of the year. The Muni market sold off about 2% in March, and it was driven by, you know, what are pretty routine technicals, which is Muni issuers tend to continue to issue a lot of debt in March and April.

And US taxpayers, they take money outta Muni vehicles to go pay their taxes. So pretty weak technical time period. What and again, this is all, you know, pre liberation day,  what made things even more unique this year is that there's a lot of Muni issuers that are fearful that there could be a change to the tax policy that would affect them, and they wouldn't be able to issue tax exempt bonds anymore.

So those issuers, and a lot of 'em are higher education, private activity bonds, they've been rushing to market to try to get deals in. And so the new issue supply numbers last year was a pretty big year. This year we're running about 40% above last year, so pretty close to an all-time record. So this was all, you know, pre liberation day.

And I would say you know, really kind of technical driven. What changed was, you know, the announcements on tariffs in evolving macro backdrop where, you know, kind of big picture growth estimates have been going down, inflation estimates have been going up, and unpredictability and volatility has been going up, and we've seen that in all markets. And US retail, any investors, you know, they don't react that well to volatility.

Historically, this is really no exception. About $3 billion in outflows outta the asset class this week. And that pushed Muni prices to very stress levels. If you had interviewed me at this time yesterday, I would've told you Munis are just finishing their biggest sell off since COVID. We were buying, you know, very, very high quality double A, triple A Munis in the 30 year part of the curve at higher yields than 30 year treasuries, which is a pretty rare occurrence.

After the pause investors have come back, I'd say a little bit, and at least stabilized things. And I think I just saw a headline before I came downstairs. Today will now be the biggest rally since COVID in the Muni market, about 50 basis points lower. So really volatile time period. A lot of stress liquidity in the Muni market. Banks, broker dealers, they just don't carry as much capital as they used to. So price volatility and, you know, quite a bit of good opportunity throughout the week.

GREG HALL: Let me, I wanna talk about opportunity for sure. But Antonese, let me get you in on the conversation, 'cause you know, I think you know, Dave's bringing up the reaction function of, you know, the typical, you know, who owns Munis? It's two legged people. It's people who pay taxes, right. I'm generalizing of course, but it's a little bit different than the broad spectrum of fixed income out there. I'm just curious, what are you hearing from advisors you speak to? Where would you kind of put the level of say, fear versus greed right now?

ANTONESE ROBERTSON: Yeah, I think it's different for each investor and each advisor that I'm talking to. You know, obviously we saw that volatility spiked, and as Dave mentioned, there were headlines everywhere. And so I was fielding a lot of questions from advisors. Some of them are very freaked out, and they're wondering, should I take chips off of the table? Should I lower my exposure to Munis? Others are seeing this as, is this a great entry point, should I be adding in?

But I think overall, you know, we are facing this great wall of uncertainty, the storm of uncertainty, and clients just wanna figure out, how do I make it through? One of the biggest questions, and you touched on this earlier, is tax exemption. Is that going away? If so, how is that going to impact my clients and their portfolios? And how should they be positioning today to handle that through the rest of the year?

GREG HALL: You wanna tackle that, Dave?

DAVE HAMMER: Yeah, I mean that's the big question for the market. And I think the, you know, the cloud that tax policy headlines have created certainly, you know, have a lot to do with this sell off, or at least the lack of new capital stepping in here at, at really high yields. And, you know, the short answer is we think the tax exemption is safe.

The tax exempt Muni market has had really good bipartisan support throughout my entire career, and I've spent a lot of time in Washington, DC with Libby over the years. You know, why is that? Well the Muni market is a really efficient way to incentivize local citizens to finance their own infrastructure, their own local governments, you know, important public projects like building more affordable housing. Most media issuers are pretty small. More than half the issuers in the media market are sub $25 million.

And if these issuers were forced to go borrow in taxable markets they're tiny, they're not In institutional size, they would have to pay hundreds of basis points more in borrowing costs. And there was a study released a few weeks ago that put that number at about $800 billion of additional costs for state and locals over the next 10 years.

But I think it's understood how valuable this is in Washington that the beneficiaries of it are a lot of small local communities in both red and blue states. And as Libby constantly reminds us you know, the margins are razor thin here, so we don't think the tax exemption is at risk. You know, that said, policy is unpredictable. So maybe I'll just go through a couple different, you know, specific policy ideas we've seen floated in the...

GREG HALL: Oh, that'd be great! Do that.

DAVE HAMMER: Yeah. So, so first is abolishing the tax exemption completely. We think it's very unlikely that happens, you know, but I think importantly in that proposal, even in that the kinda most radical proposal, it would also include grandfathering in existing bonds. So if we're a Muni bond investor today, that would, you know, likely make your prices go up as opposed to down, 'cause they wouldn't be making any more tax-exempt Munis. The second is a 28% cap.

You know, we've heard this floated over the years, going all the way back to Obama's first term. The problem with that is it really doesn't raise a heck of a lot of money, but it would cause some dysfunction in the Muni market. So we don't think that's likely, you know, I think the last, you know, probably most likely change, if any, would actually affect Muni issuers as opposed to investors.

And this is what tax reform back in 2017 did. It actually eliminated certain types of Muni issues from refinancing themselves, tax exempt. So there was elimination of something called an advance refunding bond basically where a Muni issuer would refinance an existing tax exempt bond with a new one that pushed a lot of supply into the taxable Muni market that would've otherwise gone tax exempt.

And a number of the proposals that, that we've seen floated this time around are similar, eliminating private higher ed's ability to borrow tax-exempt, eliminating private activity bonds ability to borrow tax-exempt. Now again, you know, we think this is unlikely private activity bonds in particular, that the vast majority of those issues are for affordable housing and other multi-family housing efforts. So it would've a big impact on housing affordability. But even if any of those were to materialize you're shrinking the Muni market by somewhere between 5 and 25%. So, even in a policy surprise, we think more likely than not, it's probably actually good for Muni valuations,

GREG HALL: Shrinking the flow of new issue by 5 or 25%, right?

DAVE HAMMER: Yeah, exactly!

GREG HALL: Yeah. That's of course, that's an interesting dynamic. Just the scarcity value potentially kicks in and compensates, you know, to a degree or to a significant degree for the lack of issuance. But yeah, you mentioned raise or thin margins, you were, I think you're probably just referring to kind of the Democrat Republican margins in Congress and the majority that would be required to get something of this magnitude over the line. Right?

DAVE HAMMER: Exactly! Yeah.

GREG HALL: Yeah. And that's consistent obviously with Libby's thinking as well as you mentioned. I think it's, but it's natural that advisors and Antonese, I think you, you know, you mentioned this,  it's just in the back of people's minds, right? And until we get kind of clarity on it, it seems like something that'll kind of continue to raise its head as we talk about Munis.

ANTONESE ROBERTSON:  I agree. I think that's what clients want, just some more clarity and as you mentioned, we've had a bit of a whiplash this year or, and this week. And so I think your comments are gonna be super helpful and you know, they've heard a lot from PIMCO about how strong the fundamentals are in the credit market. And so when we see this type of volatility, I think they're left a little confused. Why is this happening? And where should we go from here?

GREG HALL: But that's, I mean, that's great. 'cause like amidst uncertainty then what can compensate you for that uncertainty is great opportunity. And before we, before we interjected, Dave was about to tell us about opportunities in his market. So why don't we, you want to go there and just talk about what looks most promising to you right now?

DAVE HAMMER: Yeah, yeah. There, you know, there's a lot to choose from at the moment. Yeah. Just start keeping things really simple, right? So why do people invest in Munis? Because they get a high tax efficient yield on their holdings and simple yields. As of yesterday, the IG Muni bond index at a 4.45, that was the highest it had been in 15 years. And if we adjust that for taxes or ask ourself, what would an investor have to earn in the taxable market to get the same after tax return? That's about 7.5%. So you'd have to take a lot of risk in other asset classes in the Muni market.

Credit quality, despite technicals being challenging recently, credit quality is really near an all-time high. You know, the average quality of the IG mini index around a plus AA minus very low default rates historically. And over the last three years, we've seen a big improvement in Muni credit quality. The short story is that the federal government allocated a lot of pandemic relief with the expectation that because of COVID tax collections would decline by 10 to 20%. So these are sales taxes, income taxes, property taxes but what's actually happened is they've accelerated higher, tax collections for state and local governments are 35% higher than they were pre COVID.

GREG HALL: Wow! Wow!

DAVE HAMMER: But all of the relief dollars have been sent out anyway. They've replenished balance sheets, so they look here in California where I sit today and the rainy day funds and reserves for the state of California are three times what they were in 2018. And 2018 was the highest they had been at about 15 years. So really peak credit conditions. So it's an opportunity today to take advantage much higher yields and to do it in an asset class. That, and if the economy slows more than expected, if we see a harder landing, if we see a pickup in defaults and some of the lower quality portions of the corporate market, we think Munis are very well insulated.

And then the kind of relative value versus other asset classes, they're just about the cheapest they've been versus treasuries in many years. And versus corporate credit, and we do this a lot at PIMCO for insurance company or bank mandates that are subject to a 21% corporate tax rate will choose between Munis and corporate bonds. And for a lot of this year, Munis just weren't cheap enough to bring in that buyer base. But at current yields there's a lot of buying from insurance companies across the United States, and that should really help with price stability.

GREG HALL: Oh, that's really interesting! That's really interesting that dynamics yeah. Not something that I think everybody appreciates who, you know, looks at this more from a wealth management perspective. Sorry, Antonese, so you about to jump in.

ANTONESE ROBERTSON: I was just gonna say, I love that you talked about California. That's a question I get from my clients who live here a lot. They see headlines about California and they wonder about the credit quality around it. So hearing that they do have a good rainy day fund that that is good to hear.

DAVE HAMMER: Yeah, I mean, the state's in great shape. A lot of the locals in California, I mean by a local Muni bond, what you're actually being repaid by is property taxes most of the time. And property taxes are a function of the assessed values. And for a long time after the financial crisis, we actually really disliked local California credit because assessed values were high and housing prices were coming down. So they had to kind of catch down to assess values.

And that was a headwind. The reverse has happened today where house prices are up 20, 25% assess values here in California, they can only rise by 2% a year due to prop 13. So you've got this long tailwind of increasing property tax collections, that means likely an improvement in the quality of your local Muni bond.

GREG HALL: Antonese, I'm sure your clients can also attest to the level of property taxes in California.

ANTONESE ROBERTSON: Oh, yeah.

GREG HALL: They'll see both sides of that equation. I guess there's a couple different places I want to go to, you know, maybe the first day of, just to drill down a little bit I, it sounds like the macro picture is really appealing, not often that you get peak yields with peak credit quality.

And there's been, as you mentioned, a whole slew of technical factors in the last 30 days that may have driven that or exacerbated it. Right? And so  that on its face just seems like a really interesting opportunity investors ought to be paying attention to. And then I wonder within that, I know that you don't feel equally about every sector, about every bond. And so I'm curious on a positioning basis, what do you like, what do you think really looks interesting and are there areas that notwithstanding the overall appeal of Munis you'd, you'd still stay away from?

DAVE HAMMER: Yeah. And maybe I'll start with the second part you know, what hasn't moved enough are high yield Muni spreads. I wrote some of these numbers down 'cause they're moving so fast before I came down. But if I look at the year, the IG Muni index is up 80, 90 basis points, the high yield Muni index is only up 50. So spreads are actually tightening on high yield Muni bonds at the same time, global credit spreads everywhere else are widening pricing at a much higher probability of recession.

We saw high yield corporate spreads blow out over the last week. The high yield Muni market you know, in our view is really still priced to perfection. Some of the very high quality portions of it that are not rated by agencies, but we rate maybe triple B internally, we think  are still investible.

You can earn a five and a half to 6% tax for yield. But the lowest credit quality portions of that market, we think are extremely risky and investors really aren't being paid for that risk. So across all of the mandates that we manage, we have been going up in quality, we've been extending a little bit of duration, buying high quality Munis, but at the same time, we've reduced some of the lowest quality portions in our portfolios.

GREG HALL: What has driven spreads tighter amidst all of this unwinding elsewhere in credit markets?

DAVE HAMMER: Yeah, I mean, there just hasn't been enough outflows to force portfolio managers that maybe own, you know, exclusively high yield or a lot of it to actually sell it. So there just hasn't been much in the way of price discovery to move valuations across that market. And the new issue market has basically shut down this week. So there's been no pressure from issuers looking to, to place new deals either.

GREG HALL: Right. And when they place new deals and that price is negotiated in the underwriting process, you know, that also sets a tone for the existing stock. Right. So we just haven't had that price discovery as you mentioned.

DAVE HAMMER: That's right! Yeah.

GREG HALL: Yeah. That fascinating! I didn't see that dynamic focused on the 6,000 other things, you know, going on right now, but that's really interesting. So you're not super excited about the high yield segment. Anything that, you know, within the high quality universe really still sticks out to you as interesting.

DAVE HAMMER: Yeah, and just to clarify, it's really the, I'd say the bottom half of the high yield index, we think is too tight and too risky. There's actually quite a bit to do in privately sourced in structured debt. These are deals that are 25 to $50 million. They're not rated. A lot of these deals are backed by multi-family real estate assets with relatively low leverage. And in our ability as a firm to go out and source many of these non-traditional investments, it's allowed us to earn high yields on average six, six and a half percent, but do it in a way that we're not exposed if there's a hard economic landing to a real monetary default. So there are good substitutes available.

You know, other things that we really like today. You know, I'd probably start with the curve. The treasury curve is steep, and the Muni curve is even steeper. And a lot of that is due to good retail demand, a lot of it through ladder based, separately managed accounts, which we have a lot of here at PIMCO. Most of that money is in the 2 to 12 year part of the curve.

Banks and insurance companies used to be really big buyers of the long end, but because their corporate tax rates lower today, they just buy a lot less. And so there's been this structural steepness where even though when the treasury curve was flat, the Muni curve was about a hundred basis points between tens and thirties. And the reason we like that so much is if you're thoughtful about where you invest on the curve, and right now that's around 15 to 18 years, you can earn not just your yield, but you get good price appreciation as the bond rolls down a very steep curve.

And those numbers are, you know, in the low sixes today, which is pretty exceptional. Other parts of the market we like, you know, I mentioned pre-paid gas bonds. These are structured transactions, the partnership between a US financial institution and a power company and the US financial institution partners with them to deliver lower cost power.

Goldman Sachs has a lot of bonds, outstanding Morgan Stanley, and many of those bonds have traded as cheap in the last few days as their taxable counterparts. So that's been a good opportunity.

You know, coming back to multifamily housing debt, we've seen a lot of opportunities to source and structure our own deals. But for deals that are stabilized agencies will guarantee a big portion of their debt. And this is Freddie Mac, Fannie Mae, we've had a big overweight agency mortgages here at PIMCO, and this has allowed us to express that same view, but in tax exempt form. So, that's been a new opportunity.

A lot of it's because banks have been stepping back. These were not big parts of our portfolio a few years ago, but now an aggregate between some of the agency risks, some of the multifamily housing risk, that's somewhere in the neighborhood of 10 to 15% of most of the portfolios we manage.

GREG HALL: That's awesome! That's great! Great detail. And a little more granularity in terms of what looks interesting. You mentioned separately managed accounts, SMAs, which it just put me in mind, you know, I'm curious Antonese, there's a lot of different ways clients consume municipal bonds or invest in municipal bonds. With us, do you wanna run through just some of the vehicle structures that are popular in your market and maybe what about them appeals?

ANTONESE ROBERTSON: Yeah, yeah, it's a good segue. You know, I talk about the different vehicles, whether it's mutual funds and ETFs, or SMAs with clients a lot. And the analogy that I like to use is pool analogies. And Greg, I know, you know, you're on the east coast, so you might not know this, but us west coasters, we know a thing or two about swimming pools.

GREG HALL: Oh we have swimming pools, Antonese, come on.

ANTONESE ROBERTSON: But when I think about mutual funds and ETFs, it's kind of like being at a public pool, right? They're affordable, they're good, they're easily accessible. They might be managed by professionals and maintained by professionals but you don't have as much control over who else is swimming in that pool. And that's what you get with mutual funds. You might get higher returns, but you're also in a pool with other people.

Where you get some of that control is using SMAs or separately managed accounts. Think of that as your private backyard pool. You have full say over the layout, over the structure. You can tell who can come in and who can go out. You don't have to worry about someone cannon balling next to you. Just to really go in on that analogy.

GREG HALL: Wow! You're really extending the metaphor. I like it.

ANTONESE ROBERTSON: But it, that's what SMAs are, right? They're tailored to your needs. So for those clients who may want California specific structures, an SMA may work for you.

So I think for my clients, the great part of that is you don't have to use one vehicle over the other. When you're building this really well constructed Muni portfolio, you can blend some of those together to create a portfolio that matches your goals and your client's needs.

GREG HALL: Dave, I that makes you the pool manager. I'm curious how you think about, you know, 'cause from your perspective, I would imagine you agree with a lot of what Antonese had to say there, but then, you know, you probably see some of the benefits of managing a big vehicle versus a small vehicle.

So from your perspective, Dave, you know, how do you think about the different vehicle types and how to use them most effectively for your franchise?

DAVE HAMMER: Yeah, you know, I think what we strive to do here is we deliver one investment process into all these vehicles. And so I think that's probably one of our advantages in the marketplace. We're about evenly split between separate accounts and funds of some sort. So we, you know, like say we really are you know, kind of unbiased here.

And, you know, I think the pool analogy is a good one. And in a backyard pool, you know, you control what it looks like. So with separate accounts you can customize you can choose to harvest losses or not harvest losses. Allow us to harvest losses. You best efforts on your behalf. You know, what you might give up for that is a little bit of excess return. They tend to not be as active as our pooled vehicles.

The more flexibility we generally have, you know, we think the better risk adjusted return we can deliver, the more tools in our toolkit we can deploy to take advantage of what is a really, really inefficient market. And the Muni market very fertile grounds for active investors. Different call dates, call prices, coupons, issuers, retail investors, a lot of non-economic selling. And so the more flexibility we have at the higher return we can shoot for.

There was a big sell off in corporate credit markets, pricing in faster growth. The Muni market, I should say big rally in other markets, pricing in faster growth.

The Muni market sold off dramatically because retail investors were afraid of tax reform at higher rates, which kinda feels a lot like today. And taking money out, and the liquidity providers in the Muni market, they're just not what they used to be. Pre financial crisis, about 50 to 60 billion in inventory to buy and sell Munis every day. Today that number is down to only about 10 billion. So we see a big overshoot in prices to try to bring in a new buyer. And for our, you know, various vehicles, we managed at the time, separate accounts were mostly fully invested. So it's hard to take full advantage of it.

Our mutual funds and ETFs, we would see outflows too in these same periods. But part of what my team does here at PIMCO, we also buy Muni bonds for other parts of the firm when they get exceptionally cheap, strategies that don't care about taxes, 'cause we're looking for a total return trade, a mean reversion.

And in these big outflow cycles, we were buying lots of Munis for other parts of PIMCO. We actually couldn't buy Munis oftentimes for our dedicated investors. We then looked at our own book and said, okay, you know, how often are Muni clients using the liquidity in their portfolio? And the answer is not very often. The average hold period was many, many years.

We can draw down on a leverage line from a bank. And, you know, oftentimes by a lot of very high quality bonds, at very distress prices, just because we're in a position to take advantage of it.

The other lever we have is to really more fully allocate to some of the deals that we originate ourselves. They tend to be some of our best trade ideas, but they're less liquid and we're more comfortable running bigger exposures to less liquid investments in a vehicle that that's less liquid. So, you know, long answer, but I'd say SMAs are great if you're trying to solve a specific objective.

If you want a little bit of excess return but you value short-term liquidity, I think our open-end funds and ETFs are great solutions.

GREG HALL: Alright. That's perfect! I think I'm just looking at the time here and I know Dave, we gotta let you get back to the desk. There's still a lot going on, as much as this has been, I'm sure a welcome respite for you from data flying across the screen. Antonese crushed it with the pool analogy. I love that. And, you know, once I go to Wikipedia and figure out what a swimming pool is, I'm sure I'll appreciate it even more.

Let me just one, thank you,  thank you both for taking the time here. I hope everybody listening has found this timely and informative. There is a lot going on in the Muni market as there are in many markets right now. As always if you visit us@pimco.com, identify yourself as a financial advisor, it'll take you straight to advisor forum.

Advisor forum is our destination for you as financial advisors on the PIMCO website. It's really where you can find the information you need for your clients as quickly and efficiently as possible. It's built for you. It's aimed to deliver what you need and once there, you'll find a bunch of additional information on all the topics we covered today, including some of the solutions that Antonese and Dave were running through there at the end.

We will be back in May with another full edition of accrued interest. We may speak to you in between with a couple of extra credit episodes, depending on how market volatility continues from here. We wish you all the best of luck in these markets. We know you're guiding your clients to make good and sound financial decisions, and we're here to help. Thanks so much!