Alternative Strategy Advisers, LLC

Puerto Rico Debt - Economic Stabilization is Essential

by Randy Jacobus
Tuesday, October 8, 2013

When all is said and done, economic growth is essential for Puerto Rico bond holders. Other than first lien Cofina debt and shorter maturing second lien Cofina debt, we see other debt holders at risk if the economy is not stabilized. The current legislature are making significant steps towards balancing their budget. It is imperative that the administration induces some job creation from the Bio Tech, Pharmaceutical, and Tourist industries. it is good news that the US Feds are helping the PR legislature.

Pension Reform : One step at a Time

by Randy Jacobus
Thursday, August 29, 2013

Stockton in April, San Bernardino in August, and Detroit in September; Judges are giving Cities the opportunity to play hard ball with Unions and make needed Pension reform.

In August the SanBernardino judge ruled against Calpers stating that the City was indeed bankrupt and deserved a chance to work out their debts.

Tax Advantaged Relative Value Fund: What We Like

by Randy Jacobus
Tuesday, August 13, 2013

1) Long Duration and High Yield Muni Funds have had the most redemptions since the “Taper Talk” and therefore these sectors have seen the most aggressive selling.

Curve is extremely steep making long end look cheap.

At 5% yields, long tax exempt rates are back to historic levels, unlike Treasuries.

2) Relative to long duration Treasuries and Corporates, Municipals look very cheap.

We are approaching ratio (Muni rate divided by Treasury rate) levels that we saw during the crisis. In fact, the Gulf Zone Tax Exempt Bonds backed by Marathon Oil are now trading cheaper than the Taxable Marathon Oil Bonds. This makes no economic sense and will change.

3) We short long duration Taxable Assets to neutralize the duration risk. If interest rates go up we will make money on our hedge.

4) We believe the table is set for Municipal Bond outperformance.

High absolute rates will attract retail buyers
High tax exempt rates relative to corporate rates will attract “cross-over” buyers who will sell corporates to buy municipals.
In June, July, and August over 100 blln in reinvestment proceeds are being created by maturing municipal bonds and municipal coupons.
Increasing local tax collections are helping improve State and Local credits.
High State and Federal Income taxes are making the tax exemption more valuable.

5) If the relationship between tax exempt bonds and the taxable bonds normalizes to equal yields, the TARV return profile looks very attractive.
Structured holdings = 50% return = 50% of portfolio = 25% return allocation
Liquidity holdings = 15% return= 50% of portfolio = 7.5% return allocation
Total on hedged portfolio = 25% + 7.5% = 32.5% if Muni yields and Treasury yields converge.

6) Fund does not use leverage to buy Municipal Bonds

Muni Update

by Randy Jacobus
Tuesday, August 6, 2013

ASA believes that long duration municipal yields have reached levels that look historically attractive to investors and that relative to Treasury yields look attractive to hedged investors or cross over buyers. In addition, credits are generally improving with increasing tax receipts, supply is very supportive of lower municipal yields, and Federal/State tax rates are high.

1) Negative Fund flows are leading to cheaper long duration yields and a steeper curve.
Open End Funds, Life Insurance Companies, Banks and Broker Dealers have been significant buyers of long duration muni assets. The recent bout of Fund redemptions have increased long duration yields and steepened the municipal curve.

2) Where are high quality 30yr Municipal yields and are they attractive?
The graph below shows the yields of 30yr AA rated NY Water bonds (blue) and 30yr Treasuries in green. Please note that only during the Lehman and Meredith Whitney credit scares were yields over 5%; even with Treasury yields substantially higher.

3) Are Municipal yields cheap relative to taxable (Treasury) yields?
Retail owns approximately 65% of the municipal market. The remaining 35% are owned by institutions, including insurance companies and banks. These institutions often gauge their muni investments based on their relative value to taxable fixed income markets. The graph below shows the ratio between Municipal yields and Treasury yields.

4) Supply
The amount of reinvestment proceeds created by maturing bonds and coupons is large. At some point it will be reinvested in Municipal Bonds.

5) Detroit Bankruptcy market ramifications?

Although the Detroit bankruptcy is no surprise, there are two important takeaways:

The Bankruptcy plan reemphasizes our theme of owning bonds backed by DEDICATED sources of revenue versus bonds supported by GENERAL FUND BALANCES. There is a subtle but very important distinction between bonds that are backed by unlimited taxing authority and dedicated (and unlimited) taxing authority. The taxes raised for the bonds backed by the DEDICATED source can only be used to pay debt service.
Stay away from bonds in areas where no one wants to live and pay taxes. The population of Detroit has shrunk from 2 mlln in the 1950s to 700,000 today. As much as 40% of the taxable lots are vacant. Without taxable assets, revenue sources dwindle and bankruptcy judge needs to decide an “equitable” way of satisfying creditors.
We believe the negative headlines will draw “new” attention to “old” problems and may result in some further retail redemptions. We do not believe the Detroit bankruptcy to be the “norm” and in fact, see most City finances improving with increased property values and tax revenues.

Municipal Markets

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