High-yield munis had a great 2023, but this year may disappoint

investmentnews.com:

Money managers don’t anticipate another banner year for high-yield municipals, one of the best-performing sectors of U.S. debt in 2023.

Junk muni bonds posted a 9.2% advance for the full year, the most since 2019. Returns were buoyed by a lack of high-yield supply and a widespread market rally starting in November. 

The market could look different this year if the Federal Reserve cuts interest rates and muni issuers rush to borrow. A slowing U.S. economy also doesn’t bode well for a sector that’s largely made up of nursing homes, tobacco bonds and charter schools, said John Flahive, head of fixed income at BNY Mellon Wealth Management.

“It’s really hard to get excited about the outlook for some of those sectors,” he said.

His concerns were echoed in a recent survey published by Hilltop Securities, which showed that respondents expect the most defaults in senior living this year. About 45% of those responses were from investors in high-yield munis. 

Flahive doesn’t see high-yield munis replicating their 2023 performance, saying that the rally late last year was likely a rebound from the drop the sector saw during the bond-market downturn in 2022.

Barclays, meanwhile, anticipates supply ticking up moderately and institutional investors gradually returning to risky muni debt to chase yield. Still, it forecasts mid-to-low single digit returns for high-yield munis in 2024.

“We do not expect a repeat of 9% this year,” said Mikhail Foux, head of municipal strategy at Barclays. 

Another catalyst that could impact high-yield performance is the upcoming presidential election, because new economic policies influence portfolio construction, said Max Christiana, portfolio manager at Belle Haven Investments. 

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