Yesterday I found a couple of articles about an increasingly popular subject these days-- the various fiscal troubles that municipalities are now facing. This was a sort of looming threat a couple of years ago in terms of lower income tax for states because of the employment situation, lower sales tax revenue due to decreasing disposable income and lower property tax revenue due to dropping values and increased vacancies. These all stand to impair the various places along the municipal food chain that receive these revenues.
There have been three cities in California to go into bankruptcy and now Compton may need to take that same action in a few weeks. I recently wrote a post about city employees, including police and fire, in Scranton, PA now earning minimum wage while the city figures a few things out.
This article from the WSJ isolates threats at the state level tied to things like underfunded pensions and various forms of revenue and budget short falls. For several years I have been saying that muni bonds have become very risky relative to their own histories (as an asset class). Municipalities are confronting serious issues they have not confronted in decades (the Great Depression?) if ever.
Meredith Whitney drew a lot of flack for a big prediction about a lot of defaults that were supposed to have happened long before now but did not. Before the last few weeks there were a couple here and there but not on the scale that Whitney called for. In terms of number of bankruptcies it seems unlikely that Whitney will end up being correct but in terms of their being far more bankruptcies than there ever has been before, that seems very plausible.
The economy is impaired versus "normal" so it stands to reason that revenues of states, counties and cities will remain impaired. I tweeted about this yesterday including mentioning my ongoing belief that the worst financial crisis in 80 years will take many years to play out.
I've mostly avoided the space for clients for several years expect to stay away for quite a while. To me this is pretty simple in that the relative health of many municipalities is very poor and the various retirement obligations aren't going to disappear which creates visibility for the problems to continue. Some investors will absolutely seek and find opportunity in this space but I would prefer to take risks in the equity portion of portfolio than the fixed income portion but people do see this differently.
There has been a little bit of pushback against my belief of more fundamental shoes to drop. I think this has been because there have been some great trades along the way but I have been saying all along that would be the case. For my money there continue to be weak fundamentals and signs that the banks have learned nothing from the experience. Obviously anyone believing otherwise would be comfortable with the banks and muni bonds but I am glad to leave those segments to other people for the time being.
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16 comments:
Sorry I can't agree that Meredith Whitney was anything more than EXACTLY wrong about her prediction. We all knew there were many states and cities in deep trouble (still are) But she tried to kill muni funds by saying there would be $100s of BILLIONS of defaults in next 12 months and the actual number, was $2-3 Billion!!! Totally irresponsible. John B
Hi Roger, One of the problems with running a blog and an ETF is that you may get questions like this one. And I have no problem asking it as you have used this blog to provide information about/promote RRGR.
Can you explain why your expense rate is seemingly so high. Additionally, do you invest in other ETFs so that the true cost is both your fee as well as the other fund's fee.
Thanks
I tend to agree: The crash of '08 was part of a much larger credit crisis w/ major structural and regulatory problems in the financial sector in particular, many of which remain; there are (potentially) other shoes that could drop w/o a doubt.
The only reason a union like the USA works as a whole economically is because it controls its own currency and economic transfers (fiscal, labor, trade) between states occur with relative ease; e.g., poorer states receive more federal support than they pay in taxes while wealthier states receive less and this counteracts the trade and/or labor imbalances that tend to work the other way.
Not only the existence but the regulation of those transfers is critical and, as the EuroZone is discovering, you can't have a successful union w/o these qualities.
WRT municipalities, there are a number in serious trouble because fiscal transfers have stalled, largely for political/ideological reasons, and Whitney (who is a very sharp cookie) saw the trouble but made the fundamental error of analyzing municipalities in the same terms as corporations. She got it wrong and I am finding some fantastic bargains in the space because she is not alone and a lot of folks have been selling 1st class paper as if it was garbage.
We are the subadvisor of the fund. The prospectus notes that as managers of the fund we are paid 0.35% of assets. The fund provider is entitled to income off of the product and there are expenses that the fund must pay.
A fund manager will either add value over the expense ratio or they won't and then the market place will vote with their dollars.
When a fund owns other ETFs it is the same as a person owning ETFs directly in that the price of the fund (and so the value in your account) is net of the fund fees.
Where our fund is actively managed the holdings will change and so in the future there could be more or fewer ETFs and so the expense of owning ETFs will change.
The only problem with your question is making sure I stay within the rules of commenting.
When someone puts themselves out there as I probably have they are subject to questions and again I believe completely that if we add value in this wrapper then the fund will succeed and if not then the fund will struggle AUM-wise.
Roger, I saw 7:38's comment and thought about defending you, but didn't because you can very ably defend yourself. My thoughts along the 7:38's line: RRGR's expense ratio is actually on the low end of actively managed ETFs; that said, you still face a strong headwind. Your investment philosophy, as I understand it, is to stay invested, get defensive when demand is weak and suffer only 50% of the decline, be more aggressive when demand is strong and get 75%+ of the upside, and exceed the market's return over the entire cycle. I think that investment philosophy has merit and will overcome the expense ration headwind, and I intend to give RRGR the opportunity to prove it. If I misstated something, please correct. Thank you.
75/50 is more of a concept that influences as opposed to a target objective.
The aim of our management style is to try to add value over the course of the entire stock market cycle and we try to convey to prospective clients that thinking in three month time increments is probably a bad fit.
I read somewhere that municipalities cannot change their pension obligations even under bankruptcy. If this is true, this is insane. In the worse financial calamity in 100 years and using simple math for future projections, there has to be a drastic change.
Regarding the fiscal state and future of cities, counties, states, and the federal government. Politicians at all levels have to, unlike in previous years, truly fulfill their fiduciary responsibilities in handling the tax dollars they are entrusted with. Its not magic money (as many who spend tax dollars think), its real money put there by the taxpayers, who are the bosses and the people public servants have to answer to. When public employee unions demand ever-and-ever bigger benefit packages, the elected official must do his duty, even if it means he will not get that big campaign contribution, and agree to only that which is fiscally responsible. The voting public has to wake up, also, and demand accountability.
"...read somewhere that municipalities cannot change their pension obligations ..."
Can't imagine who would write something like that.
In states that allow municipal bankruptcy under Chapter 9 of the federal code, workers are not shielded from the impact; e.g., Stockton, CA slashed worker benefits just before declaring bankruptcy, payroll and retiree benefits alike. However, 25 states do not allow municipalities to file under Chapter 9, so the variance nationwide is quite large.
NB: Unlike a business, municipalities can not liquidate in a bankruptcy nor can they easily refuse essential services although they can cut their level. This is one reason special revenue bonds (SR's) do much better in these circumstances: unlike general obligation (GO) bonds which can be treated as unsecured debt during Chapter 9, SR bonds are considered secured and must be paid.
I tend to focus on GO's of cities where I have a lot of confidence in management, SR's in cities where I don't but the project in question has strong features. My own experience is that the biggest cause of trouble in cities is fiscal mismanagement; at the other end I've never heard of a Chapter 9 where worker benefits was cited as a cause of the bankruptcy.
Roger, I agree with your fundamental analysis regarding the precarious state of muni's. And yet if you look at an ETF like MUB, it's up almost 8% since last July. What do you think explains this discrepancy between the fundamental fiscal problems of municipalities and investors willing to bet on their bonds?
Dave,
There are similarities to what is going on in the treasury market too. The fundies underpinning the US and its debt are weaker than they have been in decades yet there is still plenty of demand.
At some point folks really do need to mark their beliefs to market; just say'n.
CHART VWIUX(MUB) TO SPY FOR THE LAST FIVE YEARS CHART MUNIS DURING THE DEPRESSION OF THE 30S AS TO DEFAULT %. Managing risk in my retirement, I have done well being out of equities for the last five years with 100% in vwiux. I have been waiting for the pullback inequities to 950 to 1000 level to get back in.
6:14, Yes, for five years munis have beaten stocks but for three years stocks have crushed munis. Neither tidbit tells us anything about the future.
If there turns out to be a muni crisis then VWIUX will get badly hurt and if there is no crisis then the fund will continue to do well. Neither tidbit changes the risk of being 100% in any single thing.
Since I have been retired for since 2000 and been in vwiux the whole time, it appears my decision has been a good one. I did miss the drop in 2008/2009 but it taught me not to miss the next one------at my age, I "hope" it happens in 2013 so I can make some "change"
"The fundies underpinning the US and its debt are weaker than they have been in decades yet there is still plenty of demand."
Folks, this is how bubbles happen.
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