MARKET REVIEW
1st Quarter 2013

he municipal bond market was surprisingly quiet during the first quarter. Global macroeconomic issues like Cyprus, the Euro and China didn’t impact supply and demand for taxexempt bonds. Newgate’s Municipal Income Portfolio gained 0.12%, compared to 0.34% for the S&P National AMT-Free Muni Bond Index.

Political and economic issues do move the municipal market, but there was little activity in these areas. The most important issue is regarding a “cap” on the tax-exempt nature of municipal bonds for high income earners. This cap has been part of President Obama’s budget proposals since 2011 and appeared in his 2014 budget submitted in April. A number of issuers have suggested that such a change would result in postponement or cancellation of infrastructure projects. However, at the same time, the President has called for the creation of America Fast Forward (AFF) bonds, a recreation of the very popular Build America Bonds from the administration’s first term. Municipal bond watchers suggest that the two might be related, with AFF providing funding for infrastructure projects, while reducing the cost of the tax exemption on municipal bonds. Thus far, the municipal market has not reacted to what might or might not be happening in Washington.

Investors are focusing on the relative attractiveness of municipal bonds compared to treasuries. Yields on a 10 year AAA municipal bond are now greater than a US Treasury yield, on a pre-tax basis. There is some evidence that even investors who do not pay income tax are buying these bonds for diversification. The municipal bond curve has steepened recently, making the leverage present in many municipal closed-end funds attractive. It also makes ETFs, which are unleveraged, relatively less advantageous.

There was also an increase in the perceived credit-worthiness of several major municipal bond issuers. For most of the quarter, economic data (particularly employment statistics) have been better than expected. More people working improves sales tax receipts, toll revenues, and other sources of income for both general obligation and revenue bonds. Weakness at the end of the quarter and in early April has slowed this trend, with Moody’s increasing the number of issuers on negative credit watch.

There have been enough positive factors in the market for the Newgate Portfolio to be nearly fully invested, compared with over 25% cash levels at the beginning of the year. Discounts on closed-end funds have widened to almost 6%. That is not wide by long-term historical standards, but it represents a considerable increase from last year, when many funds were trading at premiums. We also sold the ETFs in the Portfolio in favor of leveraged funds. Included in the sale of ETFs was our only exposure to high yield municipals, the Market Vectors High Yield Municipal Index ETF (HYD). We are finding the best value in single state funds from Maryland and Pennsylvania, each yielding over 5% with a greater than 6% discount.

The fully invested and leveraged Portfolio still has a relatively low 5.6 years duration. We allowed it to increase at the end of the quarter, as the softer economic data in March reduced the probability that short term rates will increase in the near term. At the same time, the increased steepness of the municipal curve is rewarding the extension of maturities. In a low yield environment, closed-end funds offer value for investors seeking tax-exempt income.