On the heels of a strong year, 2019 is off to a solid start. The overall municipal market is up 70 basis points as of January 31, according to the Bloomberg Barclays Municipal Index, a widely used measure of the market’s performance.1 Oppenheimer Rochester Short Duration High Yield (OPITX) is up 130 basis points (bps), Oppenheimer Short Term Municipal Fund (ORSTX) is up 50 bps, and the bps increases on the remaining 11 funds are all within the 50 to 130 bps range.
Of course, one month does not a record make. In 2018, all 13 Rochester funds generated a positive 1-year total return at net asset value (NAV). Additionally, as of December 31, 2018, seven Rochester funds were No. 1 in their respective Lipper municipal bond fund categories for the 1-, 3-, 5- and 10-year periods: OPITX, Oppenheimer Rochester High Yield Municipal Fund (ORNAX), Oppenheimer Rochester AMT-Free Municipal Fund (OPTAX), Oppenheimer Rochester Fund Municipals (RMUNX), Oppenheimer Rochester Limited Term New York Municipal Fund (LTNYX), Oppenheimer Rochester Pennsylvania Municipal Fund (OPATX), and Oppenheimer Rochester Limited Term California Municipal Fund (OLCAX).
At the end of January, the Class A shares of most of our Rochester funds were also providing strong short- and long-term performance. According to Lipper, 12 of our 13 funds had top-quartile performance for the 1-, 3-, 5-, and (where applicable) 10-year periods ended January 31, 2019, including 6 that were in the top 5% for total return in their respective categories: ORNAX, OPTAX, OPATX, Oppenheimer Rochester AMT-Free New York Municipal Fund (OPNYX), Oppenheimer Rochester California Municipal Fund (OPCAX), and Oppenheimer Rochester New Jersey Municipal Fund (ONJAX).
Our funds’ 10-year average annual total returns (AATRs) have also been highly attractive. Despite the expectation of rising interest rates and Puerto Rico’s debt situation, the AATR at net asset value for ORNAX was 10.15% as of January 31, compared to a Lipper category average of 7.13%. RMUNX generated an AATR of 8.18% vs. a category average of 4.51%, OPCAX produced a 9.43% AATR vs. a category average of 5.32%, and OPTAX offered an AATR of 9.53% vs. a category average of 4.88%. And lest anyone think that these performance figures are merely the result of a strong 2009, the 5-year AATRs for OPTAX is 317 bps higher than the average fund in its Lipper category as of January 31, 2019, and ORNAX and OPCAX beat their category averages by 244 and 205 bps, respectively.
Our team’s focus on building diverse portfolios and relying on tax-free yield to drive long-term performance has led Morningstar to award five stars to 10 Rochester funds, 4 stars to one of our funds, and 1 star to OPITX, which remains in the high yield category even though it is a short duration fund.2
We believe we are well positioned to continue to deliver industry-leading yields, which serve to deliver the lion’s share of long-term performance. And, we suspect that many investors will find tax-free income even more appealing once April 15 rolls around and taxpayers discover the exact size of their tax bills.
Turning our attention back to 2018 for a moment, tax-exempt bonds were one of the best performing asset classes. The Bloomberg Barclays Municipal Index had a total return of 1.28%, marking the fifth consecutive years of positive total returns. The best performing asset class was the Bloomberg Barclays Municipal High Yield Index, which generated a total return of 4.76% even as the yield of the MMD, a muni market benchmark, declined 48 bps in 2018.
Long-term issuance declined by 22.3% in 2018, and volume topped out at $338.9 billion, resulting in negative net issuance of $45 billion; according to the Securities Industry and Financial Markets Association (SIFMA), this was the largest negative net supply figure in more than 2 decades. The provision in the Tax Cuts and Jobs Act that repealed advance refundings was a significant factor in 2018. A contraction in supply represents a favorable technical for munis and, in 2018, it served to offset the impact of the Federal Open Market Committee (FOMC), which raised the Fed Funds target rate four times in the year.
Fund flows typically respond to market performance, and the year started with positive flows for the industry. However, as interest rates rose and the market experienced an uptick in volatility, investors’ appetite for munis softened and investment-grade munis saw negative flows by year-end. However, investors continued to find high-yield bonds attractive, and high-yield funds ended the year with positive flows.
The retail market for munis is likely to remain healthy in 2019. Banks and insurance companies, however, are likely to continue to reduce their muni investments. Credit spreads widened a bit in December 2018 but nonetheless remain moderately tight, a condition that we believe is likely to continue in 2019. While attractive buying opportunities aren’t plentiful, our team is busy scouting out the market’s brighter spots.
During 2018, the funds continued to trim its holdings in tobacco bonds, which are backed by the 1998 Master Settlement Agreement. By selling, the funds gain great optionality to invest in other muni securities at the right price and time. The New Jersey’s Tobacco Settlement Financing Corporation and California’s Golden State Tobacco Securitization Corporation both had sizable refundings, which has led some to speculate that the market for refundings has soften. As a result, some crossover buyers appear to be less interested in subordinated zero tranches.
In general, Puerto Rico bonds performed quite well in 2018: Bloomberg Barclays’s index of the Commonwealth’s debt offered a total return of 6.0% for the year and its index of high-yield Puerto Rico debt delivered a total return of 36.4%. No surprise, then, that the Rochester funds’ holdings in Puerto Rico debt were the No. 1 driver of total return for our complex and for each of the 10 funds that hold these types of securities. (We remind investors that Oppenheimer Rochester offers three funds that cannot invest in the securities issued by Puerto Rico or other U.S. territories: Oppenheimer Rochester Intermediate Term Municipal Fund (ORRWX), Oppenheimer Municipal Fund (OPAMX), and the aforementioned ORSTX.)
On February 4, Judge Laura Taylor Swain approved the structure of the COFINA plan of adjustment, and prices of these sales-tax-revenue bonds rose on the news. The new COFINAS have implied yields of 5.6% to 5.8% and may represent as much as 10% of the Puerto Rico bond indices. This restructuring affects $17.6 billion in securities, the largest class of Puerto Rico debt, and the settlement agreement specifies that the recoveries will be 93% for COFINA seniors and 56.4% for COFINA subordinate bonds. Of paramount importance to shareholders is that the income stream will be turned on again, after nearly two years on our non-accrual list.
One week earlier, Judge Swain’s ruling on $3.2 billion of Puerto Rico Employees Retirement System (ERS) taxable bonds was overturned by the First Circuit Court of Appeals. Judge Swain had ruled that bondholders did not have a perfected lien and therefore no interest in the pension system’s remittances, loans, or holdings in a certain segregated account; the appellate court thought otherwise, ruling that the “bondholders’ security issue was perfected” and remanding the case to the district court. For those investors keeping count, the First Circuit is now four for four, having overturned all four of Judge Swain’s rulings that have been appealed. According to attorney/muni watcher John Mudd, “at least three appeals remain.”
The Oversight Board created under PROMESA and the Unsecured Creditors Committee (UCC) are seeking to have all $6 billion of general obligation (G.O.) bonds issued by Puerto Rico in 2012 and 2014 declared null and void. These bonds, which are in default, represent less than 0.2% of the Rochester complex’s market value. We are closely monitoring developments on these bonds and are currently letting others fight the legal battle.
In closing, we remind investors that Oppenheimer Municipal Fund (OPAMX) is the newest of our 6 national funds.3 It can be found in the Morningstar national long category. It can hold up to 15% of below-investment-grade assets (measured at time of purchase) and has a cap of 40% of assets on BBB-rated, non-rated, and below-investment-grade securities combined.
Additionally, Invesco’s acquisition of OppenheimerFunds, which was announced in October 2018 and is expected to close near the end of the second quarter of 2019, has led to many conversations between leaders of the two companies. Our team is happy with the tenor of those discussions as we have been told that there will be no significant changes to the Rochester team, location, process, or investment style at close. All funds will have Invesco added to the front of the names, but ticker symbols will remain as is. The Invesco leadership has praised OppenheimerFunds’ “culture and commitment to high-conviction investing,” and that should bode well for our current shareholders.
- ^The Bloomberg Barclays Municipal Bond Index is an unmanaged index of a broad range of investment-grade municipal bonds that measures the performance of the general municipal bond market. Index performance is shown for illustrative purposes only and does not predict or depict performance of our funds. Past performance does not guarantee future results.
- ^The Morningstar Rating™ for funds, or “star rating”, is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods. Morningstar Rating is for the A share class only; other classes may have different performance characteristics. Past performance is no guarantee of future results.
- ^The fund changed its investment strategy from focusing on investing in Minnesota municipal securities to national municipal securities on October 15, 2018.
Fixed income investing can entail credit and interest rate risks; as interest rates rise, bond prices generally fall and a fund’s share price can fall, too. A portion of a municipal bond fund’s distributions may be subject to tax and may increase taxes for investors subject to federal alternative minimum tax. Capital gains distributions are taxable as capital gains.
Below-investment-grade (“high yield” or “junk”) bonds are more at risk of default and are subject to liquidity risk. Under certain market conditions, some unrated securities may trade less actively than rated securities. Our funds can have a relatively high portion of their portfolio holdings in particular segments of the municipal securities market, such as tobacco bonds or real-estate-related securities. They may also invest substantially in municipal securities within a single state or related to similar type projects, which can increase volatility and exposure to regional issues. Funds may also invest substantially in Puerto Rico and other U.S. territories, commonwealths and possessions, and could be exposed to their local political and economic conditions. Deterioration of the Puerto Rican economy could have an adverse impact on Puerto Rican bonds and the performance of the Rochester municipal funds that hold them. Diversification does not guarantee profit or protect against loss.