1Q 2020 — Tax-Free Fixed Income

Jamie Mullen
Senior Portfolio Manager

The Navigator® Tax-Free Fixed Income strategy finished the first quarter slightly down, yet ahead of its benchmark on a relative basis. The first quarter was challenging for the muni market, as extreme volatility stemming from the coronavirus pandemic and a resulting economic slowdown pushed valuations down across all asset classes.

The muni market, which is typically viewed as a safe asset class, was not immune to this panic selling, as muni bond yields observed levels of volatility not observed since the 2008 financial crisis. After experiencing 60 consecutive weeks of positive inflows totaling over $120 billion in new money, investors sentiment quickly changed in March. The asset class witnessed a record exodus during the last four weeks of the month totaling $28 billion, according to Lipper, forcing municipal funds to liquidate high quality positions into an already stressed market, sending yields soaring across the curve.

March began with the 5-year Bloomberg Municipal AAA curve yielding 0.69% and ending at 1.14%, an increase of 49 basis points. Another valuation metric, the AAA / Treasury ratio, quickly expanded as a result of the frenzied selling observed during this time period. The 5-year ratio was 73.1% on March 2nd, meaning that municipal bonds on average yielded around 73% to comparable treasuries of similar maturity. The muni to US Treasury ratio on March 31st was 298.4%. These higher yields and widening ratios create an attractive backdrop for municipal bonds, especially when factoring in the tax-exempt income stream received when owning municipal bonds.

Municipal Outlook

In our view, municipal bonds continue to provide some of the best credits in the global fixed income arena. The recent repricing in the market has created an attractive backdrop for municipal bonds as we observed yields rising from 0.69% at the beginning of March to 1.14% at the end of March, using the 5-year Bloomberg AAA curve as a reference point.

These higher yielding municipal bonds may become attractive for cross-over buyers, such as banks and insurance companies, as yields in the municipal market start to compete with other high-quality markets such as investment grade credit. We believe the return of these cross-over buyers would help stabilize the market, increase liquidity and constrain future volatility, and potentially drive positive returns as more participants enter the municipal market searching for attractive yields.

We believe state and local governments will continue to experience revenue shortfalls as social distancing guidelines are enforced during this time period. As result, we anticipate credit downgrades as we move through the next phase of the coronavirus cycle, particularly for municipalities with high debt burdens and lower credit ratings. In this environment, we believe active management will help add value to municipal fixed income portfolios. In our strategy, we are focused on adding high quality and essential service revenue bonds and are avoiding what we believe are troubled, lower quality credits such as airports, stadiums and tobacco bonds.

The views expressed are those of the author(s) and do not necessarily reflect the views of Clark Capital Management Group. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. There is no guarantee of the future performance of any Clark Capital investments portfolio. Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, other investments or to adopt any investment strategy or strategies. For educational use only. This information is not intended to serve as investment advice. This material is not intended to be relied upon as a forecast or research. The investment or strategy discussed may not be suitable for all investors. Investors must make their own decisions based on their specific investment objectives and financial circumstances. Past performance does not guarantee future results.

The S&P 500 measures the performance of the 500 leading companies in leading industries of the U.S. economy, capturing 75% of U.S. equities.

Fixed income securities are subject to certain risks including, but not limited to: interest rate (changes in interest rates may cause a decline in market value of an investment), credit, payment, call (some bonds allow the issuer to call a bond for redemption before it matures), and extension (principal repayments may not occur as quickly as anticipated, causing the expected maturity of a security to increase)

Bloomberg Barclays U.S. Aggregate Bond Index: The index is unmanaged and measures the performance of the investment grade, U.S. dollar denominated, fixed-rate taxable bond market, including Treasuries and government-related and corporate securities that have a remaining maturity of at least one year.

The Bloomberg Barclays 5 Year Municipal Bond Index is a capitalization weighted bond index created by Bloomberg Barclays intended to be representative of major municipal bonds of all quality ratings with an average maturity of approximately five years.

The Bloomberg Barclays Municipal AAA Index is the AAA component of the Bloomberg Barclays U.S. Municipal Bond Index

The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market’s expectation of volatility implied by S&P 500 index options.

The Dow Jones Industrial Average Index is a price-weighted average of 30 actively traded blue chip stocks as selected by the editors of the Wall Street Journal.

S&P Global Ratings issue credit rating is a forward-looking opinion about the creditworthiness of an obligor with respect to a specific financial obligation, a specific class of financial obligations, or a specific financial program (including ratings on medium-term note programs and commercial paper programs). It takes into consideration the creditworthiness of guarantors, insurers, or other forms of credit enhancement on the obligation and takes into account the currency in which the obligation is denominated. The opinion reflects S&P Global Ratings’ view of the obligor’s capacity and willingness to meet its financial commitment as they come due, and this opinion may assess terms, such as collateral security and subordination, which could affect ultimate payment in the event of default.

Refinitiv Lipper makes meaningful like-for-like comparisons across funds that share characteristics. It provides impartial fund performance data in a precise, granular fund classification system. With over 500 Lipper classifications, fund comparision is simple with similar investment mandates to benchmark fund performance.

This document may contain certain information that constitutes forward-looking statements which can be identified by the use of forward-looking terminology such as “may,” “expect,” “will,” “hope,” “forecast,” “intend,” “target,” “believe,”
and/or comparable terminology (or the negative thereof). Forward looking statements cannot be guaranteed. No assurance, representation, or warranty is made by any person that any of Clark Capital’s assumptions, expectations,
objectives, and/or goals will be achieved. Nothing contained in this document may be relied upon as a guarantee, promise, assurance, or representation as to the future.

Clark Capital Management Group, Inc. reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The information provided in this report should not be considered a recommendation to purchase or sell any particular security, sector or industry. There is no assurance that any securities, sectors or industries discussed herein will be included in an account’s portfolio. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

Clark Capital Management Group, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Clark Capital’s advisory services and fees can be found in its Form ADV which is available upon request. CCM-1129

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