Muni market grows by a hair in Q1; retail ownership ticks up driven by SMAs

Bonds

Most sectors showed flat growth of muni ownership quarter-over-quarter, but year-over-year Federal Reserve data shows the continued trend of increases in separately managed accounts and decreases in bank and insurance company holdings.

The face amount of munis outstanding ticked up to $4.081 trillion, a 0.6% increase from Q4 2023 and 1% from Q1 2023, according to the latest Fed data.

The market value of munis was at $4.001 trillion, down only 0.3% from the fourth quarter last year but up 1% from Q1 2023.

Household ownership of individual bonds was the largest category of muni ownership at 44.5%, mutual funds at 19.1%, exchange-traded funds at 3.1% and U.S. banks at 12.9%. Life insurance companies own 4.7% and property and casualty insurers at 5.3%.

“The data signaled a continuing focus on an emphasis on retail, specifically SMA-driven retail,” said Matt Fabian, a partner at Municipal Market Analytics.

The overall figures were “more or less stable” with some continued retrenchment by banks and insurance companies, he noted.

“The Fed data is reflecting some of the big picture trends we are seeing play out currently,” said Tom Kozlik, managing director and head of public policy and municipal strategy at HilltopSecurities.

“Above-average primary issuance, especially new-money activity, is causing overall numbers and trends to slightly rise,” while holdings of certain categories are falling as would be expected, he said.

Household ownership of munis — which includes direct ownership of individual bonds in brokerage accounts, fee-based advisory accounts and SMAs — rose to $1.779 trillion, up 0.3% from Q4 2023 and 5.6% in Q1 2023.

“The value of municipal bonds owned by households increased by 0.3% quarter-over-quarter, better than the 0.3% decline for the market, suggesting the likelihood that individual investors were net buyers in the quarter,” said Pat Luby, head of municipal strategy at CreditSights.

The growth of household ownership is mostly attributed to the surge of SMAs, market participants said.

Some participants on the Street estimate that SMAs hold as much as $1.5 trillion of munis while others peg it closer to $1 trillion to $1.3 trillion.

However, that growth slowed in Q1.

Total market trades were down in Q1 2024, suggesting households and SMAs were less likely to buy, Fabian said.

In the first quarter, there were just over 1 million trades each month, a drop from the 1.5 million trades each month in Q3 2023 and Q4 2023, he said.

While the first quarter was not as big of an accumulation of households, who waited to see what would happen after the large gains in Q4 2023, it looks like households are buying again in Q2, Fabian said.

Despite slowing growth in Q1, SMAs are the “dominant demand vector,” which dealers must recognize when they bring bonds or plan to buy bonds.

“SMAs, as an ‘investor class,’ are very powerful in [the muni market] market, as they are in other fixed-income markets,” said Peter Block, managing director and head of municipal strategy at Ramirez, noting SMAs are an “effective” tool for bond ownership.

Munis have always been a retail market; it’s just the “form” of the market that changes, he added.

Some regulatory changes have driven a lot of investment firms to favor SMAs and managed accounts over mutual funds, ETFs and other vehicles, Block said.

Like SMAs, ETFs have mostly seen increases in ownership.

While ETFs saw a slight dip of 0.2% from Q4 2023, they rose 15.7% from Q1 2023 to $122.3 billion. This includes net inflows of $528 million for the quarter, according to the Investment Company Institute.

The ETF market lost some momentum in the Q1 because retail investors returned to households, said Alice Cheng, a muni credit analyst at Janney.

Furthermore, some investors temporarily invested in ETFs as they waited to see what happened with market volatility, which was especially prominent last year, she said.

Those assets, Cheng said, have returned to permanent bonds or mutual funds.

Despite this, the increase in ETFs year-over-year “speaks to the growth of the product and the need for it, which has been met by the dealer community,” said Chris Brigati, senior vice president and director of strategic planning and fixed income research at SWBC.

He noted ETF ownership figures can be subject to fluctuations due to the nature of investors.

The activity in the ETF space tends to be more professional investors “doing it from the perspective of making sure they’re in a trade for a short period of time and then getting out of it,” Brigati said.

This contrasts with mutual fund investors, who are more “sticky,” he said.

“They tend not to go in one month and out in another, whereas you can easily see that type of activity in ETFs based on the professional investor nature of the use of the product,” he said.

Anecdotally, money has been moving out of mutual funds into SMAs and ETFs.

“As more investors convert from active strategy mutual funds to ETFs and lately, in particular, SMAs, sucks some of the air away from mutual funds,” and takes away some of the dollars mutual funds would historically have grabbed, Fabian said.

However, Fed data shows mutual funds slightly increased their muni holdings quarter-over-quarter and year-over-year.

Mutual funds owned 19.1% of the market at $765.6 billion in Q1 2024, rising 1.3% from Q4 2023 and 0.1% from Q1 2023. This includes net mutual fund flows for the quarter of $11.6 billion, according to ICI.

Despite these gains, Block said mutual funds are still down from their highs of $991 billion in 2001.

Both mutual funds and ETFs have their place, though the latter, which continues to grow, only represents a small percentage of the muni market, Block said.

Meanwhile, U.S. banks held were at $515.3 billion, down 3.1% quarter-over-quarter and 9.1% from Q1 2023. Insurance companies — both life insurance and property and casual insurance — were at $402.7 billion, down 2.8% from Q4 2024 and 8.9% from Q1 2023.

“The market value of bonds owned by insurance companies and banks fell by a larger percentage than the overall market, which makes sense to us,” Luby said.

Since tax-exempts were usually “too rich to make sense for investors subject to the 21% corporate tax rate, we would expect that maturing and called tax-exempts would have been replaced by taxable munis (if available) or more likely, by IG corporates,” he said.

Assuming a 21% tax rate, during the quarter, the Bloomberg BVAL 10-year single-A tax-exempt yield in Q1 ranged between 90 and 125 basis points lower than the after-tax yield of the single-A corporate benchmark yield.

Banks and insurance companies continue to shed muni holdings due to carryforward tax losses, Block said.

“A lot of these entities don’t necessarily need to buy tax-exempt bonds at certain periods, and this becomes a sort of trend where it ebbs and flows,” he noted.

Brigati argued banks and insurance companies are not necessarily “actively selling munis per se” but rather are engaged in a “steady drip of redemptions.”

“It’s not like they get redemption of monies, and they’re trying to put that back into the market; they tend to let that run off, and then they might go into other products,” he said.

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