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.
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.