Muni Market Update
Overall, the Oppenheimer Rochester municipal funds have performed well in the first four months of 2018. The ICE BofA Merrill Lynch AAA Municipal Securities Index rose 50 bps during that time frame, and for investors who pay a federal tax rate of at least 25%, munis with maturities of 5 years or more continued to provide more after-tax income than Treasuries with comparable maturities .1 The Bloomberg Barclays Municipal Index had a total return of -1.6% year to date.2 As of April 25, both the Dow Jones Industrial Average and the S&P 500 were also down for the year.
We continue to see strong performance for Oppenheimer Rochester Short Term Municipal Fund (ORSTX). Since its inception, ORSTX has won the Thomson Reuters Lipper Award for consistent returns for the 3- and 5-year periods every year it has been eligible.3
Holdings of securities issued by the Commonwealth of Puerto Rico have been a significant driver of our funds’ strong performance in 2018 (see below for details). In March, the Federal Open Market Committee (FOMC) raised the Fed Funds target rate to a range of 1.50% to 1.75%. The Fed has indicated that the rate with be raised two or three additional times this year.
Supply has dropped sharply in 2018, but ended 2017 with a burst of issuance from municipalities concerned about the potential impact of the Tax Cuts and Jobs Act. Issuance in the first quarter was just $300 million higher than December 2017 issuance. We expect 2018 supply will be nearly 30% lower than last year. While it seemed the market would see increased supply because of the federal infrastructure package, that has yet to materialize. We believe that the lack of supply will have greater impact next quarter, to the benefit of bondholders.
Taxpayers in high tax states like California, Illinois, New Jersey, New York and Pennsylvania will start to feel the impact of the Tax Cuts and Jobs Act when their 2018 tax bills come due. The loss of the federal deduction for state and local taxes (SALT) may lead some taxpayers to look anew at the tax advantages associated with muni investments.
Six months after Hurricane Maria, bonds have rallied. Despite negative headlines, we maintained our positions in Puerto Rico, and this has proved to be a good decision. The market has seen huge outperformance year-to-date in Puerto Rico bonds, and the credits are back to where they were trading before hurricane.
Two factors helped drive this performance: federal aid and a pessimist prediction that did not come to fruition.
Sales and use tax collections are significantly higher than predicted. The amount was projected as zero for several months though this has been far from the case. We continue to believe that COFINA covenants, which specified that debt service would be paid from the special revenue pledge, are binding and enforceable.
Our team continues to believe that the best interests of all stakeholders can be met through negotiated settlements that offer Puerto Rico a path forward, strengthen its economy, and improve the quality of life of its residents while providing investors with an appropriate return.
Bonds backed by the 1998 tobacco Master Settlement Agreement continue to outperform. Our funds continue to be overweight tobacco, though the complex has taken advantage of market conditions to reduce our positions in recent years.
Tobacco is now the largest sector in high yield space, as portfolio managers across the muni market sold Puerto Rico and bought tobacco. Year to date, the Bloomberg Barclays High Yield Tobacco Index is up 1.3%.
As these details demonstrate, the Rochester portfolio management team remains committed to active management and will continue to seek to create shareholder value for investors seeking tax-free income. We appreciate your continued confidence in our team.
- ^The ICE BofA Merrill Lynch AAA Municipal Securities index is the AAA subset of the ICE BofA Merrill Lynch US Municipal Securities Index, which tracks the performance of dollar-denominated, investment-grade, tax-exempt debt issued by U.S. states and territories and their political subdivisions; index constituents are weighted based on capitalization, and accrued interest is calculated assuming next-day settlement.
- ^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.
- ^Lipper Awards are granted annually to the funds in each Lipper classification that achieve the highest score for Consistent Return, a measure of funds’ historical risk-adjusted returns, measured in local currency, relative to peers. Winners are selected using the Lipper Leader rating for Consistent Return for funds with at least 36 months of performance history as of 11/30. Awards are presented for the highest Lipper Leader for Consistent Return within each eligible classification over 3, 5 or 10 years. Other share classes may have different performance and expense characteristics. Although Lipper makes reasonable efforts to ensure the accuracy and reliability of the data contained herein, the accuracy is not guaranteed by Lipper. Lipper awards are not intended to predict future results. Past performance does not guarantee future results. Generally, Y shares are only available to certain investors, including those in wrap-fee-based programs or commissionable brokerage platforms that charge sales commission.
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.