We first highlighted the opportunities in munis back in late November. So far, year-to-date, the iShares S&P National AMT-Free Municipal Bond Fund (NYSE:MUB) is up around 6%, outperforming Treasuries as well as investment grade and high yield bonds.
While we continue to maintain a view that investors should overweight equities over bonds, within the fixed-income space we continue to advocate overweighting national munis. First, as we have argued in the past, while the states certainly have their own fiscal challenges, revenues are improving. By and large, the term structure for most municipalities – in other words the timing of their funding needs – also looks better than that for the federal government.
Second, even after their recent outperformance, munis still appear cheap relative to Treasuries. The average 10 year general obligation (GO) municipal bond is currently trading at about a 110 basis point premium to a comparable Treasury. Historically, due to the tax advantage of munis, a 10 year GO bond would typically trade at about a 70 bps discount. And again, this discount looks even more compelling when you consider the amount of supply the US Treasury needs to sell over the coming year due to chronic deficits.
In addition, currently, the yield to maturity on MUB is around 3.3% with an average maturity of less than 8 years. On a tax-adjusted basis, for upper income individuals, that 3.3% yield is the equivalent of a 5.1% yield on a taxable bond. So an investor in the top income bracket could get two full percentage points more in interest with munis than they could obtain with a 10 year Treasury. In other words, they could potentially get a much higher tax equivalent yield with a lot less interest rate or duration risk. Bottom line – we would continue to hold an overweight view of US Municipals and to advocate funding it through an underweight view of long-term US Treasuries (potential iShares solution: MUB).
Call #2: Maintain Overweight Russia
Our attention next turns toward providing an update on our short-term tactical overweight view of Russia. We first recommended the trade in early April. Since then, the iShares MSCI Russia Capped Index Fund (NYSE:ERUS) is down around 8% versus a 5% loss for a broader emerging market index. Despite the underperformance, we continue to like Russia as a tactical play.
The country is obviously not without its share of issues, but we believe these are already priced into the market. Russia trades 5.5 times next year’s earnings, making it cheaper than Pakistan. And while corporate governance is an ongoing issue, companies in the main MICEX Index are producing a healthy 20% return on earnings. Finally, it is worth noting that in this season, when many countries – from Greece to the United States – are struggling with too much debt, Russian has one of the smallest sovereign debt burdens in the world, at less than 10% of GDP.
In short, we recognize that there are significant risks associated with Russia, and we would obviously not recommend Russia to more conservative investors. But for more tactically minded investors, we believe that the challenges facing Russia are more than adequately discounted in the valuations, and as such the country represents an interesting opportunity (possible iShares solution: ERUS).
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist as well as the Global Head of Investment Strategy for BlackRock Scientific Active Equities. Russ initially joined the firm (originally Barclays Global Investors) in 2005 as a Senior Portfolio Manager in the US Market Neutral Group. Prior to joining BGI, Russ managed several research groups focused on quantitative and top down strategy. Russ began his career at Instinet in New York, where he occupied several positions in research, including Director of Investment Strategy for both US and European research. In addition, Russ served as Chief North American Strategist for State Street Bank in Boston.
Russ holds a JD from Boston College Law School, an MBA from Columbia Business School, and is a holder of the CFA designation. He is also a frequent contributor to the Wall Street Journal, New York Times, Associated Press, as well as CNBC and Bloomberg Television. In 2008, Russ published “The ETF Strategist”(Portfolio Books) focusing on using exchange traded funds to manage risk and return within a portfolio.