Jim Murphy and Charlie Hill: ‘The Value Proposition for Municipal Bonds Has Rarely Been Stronger’

Episode Summary

Executive Summary: T. Rowe Price muni managers Jim Murphy and Charlie Hill argued that municipal bonds are in a strong setup after years of rate and flow volatility: yields are now attractive, state/local credit quality is solid, and active research can uncover value in overlooked sectors like healthcare, AMT bonds, and corporate-backed munis. They also discussed election and tax-policy risks, market flows, and why active funds, ETFs, and SMAs each serve distinct roles.

Main Topics: Muni market reset and current opportunity (Priority: 5/5): Murphy framed the post-COVID, post-2022 period as a major repricing that left municipals offering much better income and stronger relative value, supported by improved issuer balance sheets and pension funding. Interest rates, curve inversion, and the Fed cut (Priority: 5/5): Hill explained that the muni curve had been inverted mainly at the front end, while the rest of the curve remained steep, and that the recent Fed cut compressed cash yields but did not fully alter the broader opportunity set. Active management and market inefficiency (Priority: 5/5): Both guests emphasized the fragmentation of munis and the need for bottom-up credit work, boots-on-the-ground research, and tax-aware trading to exploit inefficiencies in a market of many small issuers. Fund vs. individual bonds and tax-loss harvesting (Priority: 4/5): Hill argued that professionally managed funds can better manage portfolio-level rate and credit risk, while also enabling institutional-scale tax-loss harvesting and reinvestment into higher-yielding securities. Credit quality, sector selection, and healthcare (Priority: 5/5): The managers said spread opportunities remain in sectors like healthcare and corporate-backed munis, where balance sheets are strong and revenue structures can be mispriced by investors who prefer only the safest generic sectors. Election, tax policy, and muni demand (Priority: 4/5): They discussed how divided government, TCJA sunset risk, corporate tax changes, and AMT changes could boost demand for tax-exempt income and influence bank/insurer participation in munis. Flows, vehicles, and portfolio construction (Priority: 4/5): They described recovering fund/ETF inflows, the appeal of active municipal strategies, and the distinct roles of mutual funds, ETFs, and SMAs in delivering tax-exempt income and liquidity.

Key Arguments: Municipal bonds have become more attractive because yields are materially higher than in the prior decade, creating real income for investors after years of ultra-low rates. State and local credit quality improved during and after COVID thanks to federal support, stronger balance sheets, and better pension funding, reducing default concerns. The muni market is inefficient and fragmented, so active bottom-up credit research can find value that passive or rules-based approaches may miss. Buying individual muni bonds can leave investors exposed to undisclosed portfolio-wide rate and credit risk, while funds can manage those risks and harvest tax losses more effectively. Healthcare revenue bonds often offer better yields than generic GO or water/sewer credits while remaining high quality due to strong balance sheets and limited competition. Election and tax-policy changes could increase the value of municipal tax exemption, especially if corporate tax rates rise or current tax cuts sunset. High-yield municipals are not comparable to corporate junk bonds because only a small slice of the muni market is below investment grade and the average credit quality remains solid. ETFs in muni land are currently often passive and may under-represent sectors like healthcare, AMT, and lower-rated credits that active managers can exploit. Municipal market demand remains robust despite high issuance, driven by investors seeking tax-exempt income and institutions reallocating as money-market yields normalize. Geographic migration patterns and climate-related rebuilding needs are changing relative value across states and local issuers, especially in Sunbelt and coastal regions.

Data Points: Fed funds rate before cut: about 5.3% - Charlie Hill described the overnight rate before the 50-basis-point cut Fed funds rate after cut: about 4.8% - Charlie Hill discussed the immediate effect of the rate cut Overnight municipal rate before cut: about 3.3% - Hill noted the front-end muni cash rate prior to the cut Overnight municipal rate after cut: about 2.9%-3.0% - Hill described the post-cut decline in cash yields Five-year municipal yield: about 2.4% - Used in the muni-to-Treasury ratio example 30-year municipal yield: a little under 3.7% - Hill cited this as the long-end muni yield level Muni curve slope from 5-year to 30-year: about 130 basis points - Hill said this is historically steep for munis Five-year Treasury yield: about 3.9% - Used in the muni-to-Treasury ratio explanation Muni/Treasury ratio: about 61%-62% - Calculated from 2.4% muni yield vs 3.9% Treasury yield Recent treasury move after Fed cut: 3.6% to roughly 4.1% - Hill said Treasury yields rose after the cut and payroll report Treasury decline before Fed cut: about 4.25% to 3.6% - Hill described the run-up into the Fed meeting Year-to-date muni fund and ETF inflows: roughly $25 billion - Murphy said flows had turned positive in 2024 Consecutive weeks of inflows: 13 or 14 weeks - Murphy described the recent inflow streak Industry outflows in 2022: about $123 billion - Murphy described the rate-hike driven exodus from muni funds Industry outflows in 2023: about $16 billion - Murphy noted continued but smaller outflows Prior three-year inflows: about $250 billion - 2019-2021 inflows into muni funds Money market rate competing with munis: 5.25% - Murphy and Hill said cash rates made it hard for munis to attract assets Corporate tax rate under TCJA: 21% - Discussed as reducing demand from banks and insurers for muni tax exemption Potential corporate tax rate under Harris proposal: 28% - Murphy said higher corporate rates would support muni demand AMT impact if TCJA sunsets: from about 50,000 to over 7 million people - Murphy estimated potential expansion of AMT exposure High-yield muni share below investment grade: about 5% of the municipal market - Murphy emphasized that muni high yield is a small slice of the market Average credit quality in Murphy's high-yield portfolio: mid-triple-B range - He described the portfolio as still relatively conservative Healthcare balance sheet example: 2x cash to debt - Murphy cited BayCare Health as an example of strong hospital credit Healthcare balance sheet example: 3.5x cash to debt - Hill cited Inova Health as a large position with very strong liquidity Inova Health cash and investments: $7.5 billion - Hill used this to illustrate healthcare credit strength Inova Health annual operation size: $5 billion a year - Hill described the scale of the issuer Pricing edge vs. high-quality GO/water bonds: about 50 basis points more - Hill said healthcare bonds can yield more than generic high-quality munis Large hospital example: Children's Hospital of Philadelphia - Murphy used it to illustrate strong AA healthcare credits Puerto Rico problem size: $70 billion - Murphy described the scale of the Puerto Rico distress Historic muni deal size: $50 million to $75 million - Murphy described average municipal issue size as small and fragmented Portfolio split in current flows: $20 billion open-end mutual funds; $8 billion ETFs - Murphy said most muni inflows still go to mutual funds Current year muni market issuance: record issuance expected - They said issuance is on pace to hit a record, though no exact figure was given

Pivotal Quotes: "the value proposition for the asset class has really rarely been stronger in my time of doing this" — Jim Murphy: Murphy on why municipals look attractive after the rate reset and improved credit backdrop "we really view ourselves as credit investors" — Jim Murphy: Murphy describing the firm’s bottom-up approach to researching a fragmented muni market "You know, it's kind of interesting, even though fewer people are subject to AMT right now. AMT spreads have kind of remained relatively wide throughout the entire period from 2017 until today." — Charlie Hill: Hill on why AMT remains an important niche source of spread despite tax changes

Implications: For investors, the message is that munis offer better tax-free income than in years, with active management especially valuable in a fragmented market. Tax policy, rates, and flows should keep driving relative value and demand, especially in healthcare, AMT, and other mispriced sectors.