In a reversal, muni mutual funds see inflows while ETFs hit with outflows

After two consecutive years of investors pulling money from muni mutual funds, January has gotten off to a better start as the market has seen the return on inflows. 

“The driver of the improvement in net fund flows is not necessarily new buyers coming into the market; it’s the conclusion of tax loss swap selling and the redemption of shares,” said Pat Luby, a CreditSights strategist.

Higher yields also play a role, he said, for “if you’re an income-focused investor, the opportunity to lock in some higher yields is appealing.”

LSEG Lipper reports $1.15 billion of inflows into muni mutual funds year-to-date, while the Investment Company Institute reports $3.57 billion of inflows.

If fund flows into muni mutual funds continues, Jennifer Johnston, director of Municipal Bonds Research at Franklin Templeton.said it will “create a positive position and a great opportunity to move into the muni market and commit to it.”

The “encouraging” fund flow information with more money coming in “is great for the market,” said Jennifer Johnston, director of Municipal Bonds Research at Franklin Templeton.

If it continues, she said it will “create a positive position and a great opportunity to move into the muni market and commit to it.”

The inflows into muni mutual funds mark a reversal from 2022 and 2023.

Daniel J. Close, Nuveen’s head of municipals, described 2022 as the “year of the paper cut,” where each day brought outflows.

LSEG Lipper reported outflows of $66.65 billion in 2022, while ICI reported outflows of $145.16 billion

The following year saw outflows continued in 2023, though to a lesser extent. LSEG Lipper reported outflows of $8.6 billion in 2023, while ICI reported outflows of $21 billion.

Fund flows have been “beaten up pretty good” over the last several years, but that “was on the back of really strong inflows when we were in a low-interest rate environment,” said Scott Diamond, co-head of municipal fixed income at Goldman Sachs Asset Management.

Therefore, he noted it’s understandable why investors preferred the separately managed account offerings when yields moved higher.

While it’s hard to quantify money moving from mutual funds into SMAs beyond anecdotal evidence, Citi Research found that muni SMAs grew to $718 billion at the end of Q2 2023, up exponentially from $100 billion in 2008.

Along with SMAs, money has also moved into exchange-traded funds, which were a bright spot in 2023 among a slew of outflows. ETFs saw inflows of $15.29 billion in 2023, but this year, ETFs have seen outflows of $1.94 billion, according to ICI.

Luby said at least some of the money leaving ETFs is going into mutual funds.

With the slow new-issue calendar at the end of 2023, , if SMA managers or other portfolio managers “had money coming into their portfolios at the end of last year — especially after the huge performance in November — they were probably very sensitive about making sure that they’ve got clients money invested,” he said. “So the net flows out of the ETFs are some money going back into mutual funds, but also some money that’s going into individual bonds as new-issue supply is picking up.”

Close noted 2024 is starting with a bit of a reversal: inflows for 40 Act funds and outflows for ETFs.

“Part of that is due to tax loss harvesting going into the ETFs for a bit, parking it for some time to get to make sure you’re avoiding wash sale and that money coming back down,” he said.

Close said he was hopeful from a technical perspective, “that with supply relatively in check and with flows so far off to a very good start, that we’re able to continue.”

“The negative flows from 2022 and the still negative flows from 2023 are largely behind us,” said Robert DiMella, executive managing director and co-head of MacKay Municipal Managers.

He attributes negative fund flows in 2022 to the absolute reset in rates, and in 2023, in part, to tax loss harvesting, which has since largely passed.

This year, DiMella believes fund flows will be on margin more positive than negative.

With a stabilized market, Diamond said “you’ll get back to that point of parity between owning an individual bond versus a mutual fund.”

If interest rates move lower, he said cash could come back into mutual funds because the yield offering will look “pretty compelling” then.

“It won’t be every week, but at the end of the day, incomes are very attractive. Clients are looking to increase their allocation, not just in muni but fixed income in general,” DiMella said. “The mutual fund complexes, for those that are repositioned, are going to be an attractive place for clients to focus on.”

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