German pension fund | July 2017
Engagement at a glance
This German institutional investor wished to invest USD 50 million in Municipal Bonds via a fund-of-one. We sought strategies featuring primarily Taxable munis (maximum 20% tax exempt), low exposure to high yield (maximum 5%) and limits on California holdings (maximum 20%). Active management of duration was expected, with a minimum of 6 years.
Typical for German institutional investors, the client wanted the investment to be housed in a dedicated fund structure with a local management company (KVG) and a local custodian. However, municipal bond managers traditionally have a very US centric client base. The major challenge was to identify a manager combining both a solid expertise in municipal bonds and a deep understanding of the German regulatory and operational requirements.
- In the initial phase of the selection process the team scoured the full municipal bond manager universe to identify those who could satisfy the specific requirements for this German asset owner. This resulted in a thirty-strong longlist.
- From the perspective of a non-US investor, taxable municipal bonds are more attractive as they tend to offer higher yields than tax-exempt bonds with the same level of risk. Yet taxable munis represent a very small segment of the market; tax-exempt bonds have been the natural habitat of most municipal bond managers with their historically US-dominated client base.
- Taxable muni strategies also, as a result, have far shorter track records than tax-exempt strategies. As a result, quantative analysis was only of limited value and more qualitative analysis of the teams and investment processes proved to be critical in selection.
- The research highlighted five managers that united outstanding skills in the asset class and the necessary German specific experience. After a round of due diligence, one was ultimately selected by the investor.
Our specialist says
The universe of municipal bonds comprises countless issuers, many small and unsophisticated. While this provides plenty of inefficiencies and investment opportunities, the depth and dedication of credit research is critical. Investors should also favour models where experienced traders are integrated into the investment process. Effective coverage of both national and local dealers can provide vital insights on market prices to support relative value analysis and security selection.