2 Takes on Trump's Impact on Muni Bonds
President-elect Donald Trump’s proposed policies could partially change the landscape of the municipal bond market for investors in two primary ways.First, his election could put Build America Bonds (BABs) -- or a program like it -- back on the table for government issuers. BABs were introduced in 2009 and 2010 by the Obama administration as a way to stimulate the economy and create jobs. Republicans on Capitol Hill killed the program, but Trump has spoken favorably about it. He's interested in stimulating more investment in infrastructure.
Unlike regular municipal bonds, BABs aren’t tax exempt, making them more appealing to investors such as international bondholders or institutional investors who aren’t eligible to claim an exemption. Thus, they broaden the municipal bond market.
Second, an analysis by the Court Street Group Research (CSGR) says Trump’s income tax plan could affect the municipal market because it would eliminate or reduce the tax exemption for municipal bondholders. “The CSGR approaches the reality of a Trump administration with some trepidation as it applies to municipal bonds,” the analysis said.
The Takeaway: Taking all these proposals into account, and given that many are now expecting federal tax reform to roll forward in some form in 2017, these policies could reshape to some extent who buys municipal bonds.
Research by Brandeis University’s Daniel Bergstresser and MIT’s Randolph Cohen has shown that municipal debt is being increasingly held by America’s wealthiest households. If the tax exemption on income earned from that investment is eliminated for the wealthy, it provides little motivation for these bondholders to buy more municipal debt.
Who will take their place? The BAB experiment would seem to suggest that having more taxable debt in the municipal bond market will attract different kinds of investors. Stay tuned.
Panning Social Investing
A new research brief by the Center for Retirement Research concludes that pension plans’ moral responsibility to their stakeholders should trump their responsibility to the rest of the world.The analysis looked at social divesting, which is when investors dump stock not based on investment performance, but because they are morally opposed to the company’s practices. Public pension funds have been active in this arena since the 1970s, when many divested from companies doing business in South Africa in response to that country’s policy of apartheid.
The brief also looked at social investing, where investment decisions are driven by achieving social or environment goals.The investing process includes screening for morally agreeable fields like nonprofits or health-care related investments. The report found screening in public pension funds is “pervasive.” In 2014, their screened assets amounted to $2.7 trillion, more than half of their total assets.
Looking at performance, the brief referenced data comparing screened funds with comparable Vanguard mutual funds and found the latter outperformed the screened funds by a considerable margin, in part because of higher fees. The authors concluded that social investing can produce lower investment returns and thus not be in the best interests of beneficiaries and taxpayers. They also noted that divesting out of protest typically is not effective, as other investors step in to buy the stocks.
The Takeaway: In a time when public pension plans are under huge amounts of pressure to perform, decisions thatpotentially reduce their investment yield is extremely troublesome.
Most pension plans assume a rate of return above 7 percent, an assumption that many say is now an unrealistic long-term assumption. If assumptions were significantly lower, perhaps it wouldn’t matter that social investing has the potential to lower returns. But, as the brief notes, if returns aren’t met, it’s not the decision-makers who bear the risk of potential losses. That loss falls to the pension plan’s future beneficiaries and taxpayers.
CalPERS Shares $539 Million With Money Managers
The California Public Employees’ Retirement System, the nation’s largest public pension fund, paid $228.4 million in fees in fiscal year 2015-2016, and shared $539 million in profits with private equity firms, the fund announced this week. The payments were skimmed from $3.26 billion in gains, which means that CalPERS shared a whopping 14 percent of the profit made on private equity investments in the past year with firms managing the money.The Takeaway: The disclosure marks a milestone for CalPERS, which is often a trendsetter for other public pension plans. Most systems are reluctant to disclose how much they pay in fees -- partly because their money managers don’t report that back to them.
But some plans have become fed up with this system. Earlier this year, CalPERS adopted a uniform fee reporting template for its money managers. At the time, some said the move could dissuade private equity firms from wanting to do business with CalPERS. But the way CalPERS board member Richard Costigan sees it, "Every one of those funds should be disclosing and if they are not, or they are refusing, we should not be doing business with them."
The sheer size and investing prowess of CalPERS also probably helped it get its way. What remains to be seen is whether smaller plans can point to CalPERS’ arrangement and make their own money managers follow.
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