Are Muni Mutual Funds Being Played?

Are Muni Mutual Funds Being Played?

As the old Yorkshire saying goes, “Where there’s muck there’s brass.”  What could be murkier than the municipal bonds that underlie muni bond mutual funds?  I count 666 muni/tax-free mutual fund portfolios.  I track 97,215 mostly municipal securities held by those funds. Some of these bonds trade throughout the day, others, occasionally throughout the year.  

The bonds are varied in every way imaginable, from maturity to what underlies their promise to pay, from a State’s general obligation (GO bonds) to the revenues from Tollbooth 37, on exit 17 of throughway 111.  Okay, I exaggerate, but not by much.  

Some of the largest muni bonds are monetized from tobacco industry settlements. For example, “Buckeye Tobacco Settlement Financing Authority, Ohio, Tobacco Settlement Asset-Backed Revenue Bonds, Refunding Senior Lien Series 2020B-2 Class 2”  About $5.3 billion was recently refinanced.

At the other end of the spectrum, one fund holds $0.80 worth of the “New River Community Development District bond”

I have just started a detailed analysis of the funds that hold these bonds and their apparent recent volatility. Short of having internal trade data, I have to rely on the sales and redemptions data submitted to the SEC from those funds. (This data takes a few months to come in, so we’re just starting to see data from March, 2020.)

First, for context, here’s a chart, from Morningstar, of Massachusetts muni funds performance during the Covid-19 shock period.

As you can see, the volatility is extreme. 

Here’s a fund from what I’ll call a family-oriented manager; that is, all long-term investors.

As I would have predicted, redemptions rose after the shock of Covid-19 and sales decreased–locking in capital gains from the Fed’s interest rate moves.  But why would anyone buy a muni bond fund with such a narrow premium to Treasuries and so much talk of State bankruptcies?  

Let’s look at another fund, from a manager with greater Wall Street recognition.

Here, sales don’t fall in March or April, though redemptions rise.  Who is buying and selling these funds intra-monthly?

The central question is: Are there plenty of opportunities to exploit pricing anomalies in the muni bond market? Traders might drive prices up or down of $100,000 worth of bonds in the muni bond market, then buy or sell $1 million worth of mutual fund shares if they price in the distortion.

This is all HIGHLY speculative. I haven’t kept up with the rules and safeguards put in place to protect funds from market manipulations. This is my first look-see into muni bond funds.

Finally, the following is a graph of some HY muni funds with daily price changes. How can funds with similar portfolios change so much every day? That is, one day Fund ‘A’ is doing better than Fund ‘B’, and the next day they swap positions, and then again a few days later. Can we really expect the value of the underlying bonds to change daily based on thinly traded muni bonds?

If policies are not strong, can boards find themselves liable if their funds don’t actively police their funds for trading anomalies? Worse, can insiders share knowledge with outside traders, even within the same complex?

Boards or managers looking for more insight into this data, please feel free to contact me.

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