Bill Gross, whose $281 billion Total Return Fund already holds the most municipal debt in six years, says now is the time to buy more with higher taxes looming following President Barack Obama’s re-election.
With the election past, investors are turning their sights to the so-called fiscal cliff, $607 billion of spending cuts and tax increases that will start in January unless Congress acts. Obama wants to use the leverage from his victory to reach a “grand bargain” that uses tax increases and spending cuts to shrink budget deficits.
“Muni bonds, which are tax-free, would be a valuable type of asset going forward,” Gross, who manages the world’s biggest bond fund at Pacific Investment Management Co. in Newport Beach, California, said on Bloomberg Television’s Street Smart.
Pimco is looking to the $3.7 trillion muni market as local yields are at their lowest since the 1960s and as states and cities recover from the longest recession since the 1930s. State revenue has grown for 10 straight quarters, though collections are still below the 2008 peak, according to the Nelson A. Rockefeller Institute of Government in Albany, New York.
The Federal Reserve’s policy of keeping its benchmark overnight rate close to zero to help spur growth has pushed Treasury yields even lower than those on local debt.
Yields on benchmark 10-year municipals fell about 0.04 percentage point yesterday to 1.65 percent, about even with similar-maturity Treasurys, data compiled by Bloomberg show. For investors in the top tax bracket, the equivalent taxable yield is about 2.54 percent.
Yields on 10-year munis have exceeded those on Treasurys for the past year on average. That runs counter to the historical relationship, where muni yields have been about 93 percent of federal yields on average since 2001. Investors are typically willing to accept the lower yields because the interest on munis is tax-exempt.
The extra yield on munis also boosts the securities’ appeal, Gross, 68, said in an e-mail sent through Mark Porterfield, a spokesman.
Pimco has also added munis because of their relative stability compared with other fixed-income classes amid price swings generated by Europe’s debt crisis. Local bonds are poised to earn more than federal debt this year when adjusted for volatility.
Local debt has returned 4 percent in 2012 after accounting for price swings, compared with 0.6 percent for Treasurys and 2.8 percent for corporate bonds, according to data compiled by Bank of America Merrill Lynch and Bloomberg.
Gross directed 5 percent of his fund to munis in September. It was the first time he’s held that high a percentage of munis in consecutive months since at least 2006, according to Pimco’s website.
The fund has earned 9.4 percent this year, beating 94 percent of its peers, data compiled by Bloomberg show. It invests in government, mortgage and investment-grade company fixed-income securities. Pimco is a unit of Munich-based insurer Allianz SE.
Ebby Gerry, who helps manage $14 billion of munis at UBS Global Asset Management Inc. in New York, agreed that tax rates may rise.
The administration and Congress may look at changing credits or tax breaks, including curbing the exemption for munis, to reduce the deficit, Gerry said.
Obama, 51, has proposed capping the value of itemized deductions at 28 percent, down from 35 percent. At the same time, he wants to raise the top tax rate on ordinary income to 39.6 percent from 35 percent, and to increase taxes on capital gains and dividends.
“There’s a greater probability that income-tax rates will rise sooner than the full tax exemption gets lowered,” said Gerry.
In trading Wednesday, the iShares S&P National AMT-Free Municipal Bond Fund, the largest exchange-traded fund tracking munis, rose to $112.53, the highest since Feb. 22.
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