Is it Time to Stop Overlooking Municipal Bonds?

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Go

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Ryan Nauman Market Strategist Zephyr:

Hello everyone and welcome to

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Zephyr's Adjusted Risk Podcast

from the shores of Lake Tahoe.

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Fixed income has been a staple in

investment portfolios however, the

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fixed income space is vast with

different asset classes to choose from.

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In fact, the fixed income space is a

lot larger than the equity space, so it

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can pose some challenges for building.

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Investment portfolios and incorporating

fixed income into those portfolios.

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My next guess is an industry expert

who is gonna talk about a fixed

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income asset class that is often

overlooked, but offers a lot of

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benefits to portfolio construction.

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But first, this episode is sponsored

by the award-winning Zephyr, which

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helps investment professionals make

more informed investment decisions.

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On behalf of their clients.

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Alright, enough for me.

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I've already talked enough.

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Let's go ahead and bring

on the star of the show.

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I'd like to give a very

warm welcome to Eric Kazaki.

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Eric is the client portfolio manager

at Mackay Municipal Managers.

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Eric.

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you so much for coming on the show.

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It's an honor to have you on really

excited about this conversation.

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Like I was telling you before,

I don't have many conversations,

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surprisingly on municipal, so

really looking forward to this one.

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Can you tell us a little bit more about

yourself and Mackay Municipal Managers?

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Eric Kazatsky Client Portfolio Manager MacKay Municipal Managers:

Absolutely first off thanks Ryan for

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having us on and we're always happy

to talk about municipal bonds It's our

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bread and butter kind municipal managers

$85 billion closing out on $86 billion

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manager solely in the tax exempt and

taxable immunity space so that really

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is our specialty We have a suite of

products that range from exchange traded

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funds on the active side mutual funds

again actively managed and then we have

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interval funds and limited partnerships

So all across the yield curve all across

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the credit spectrum you know we try and

provide a whole host of solutions as for

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myself I'll keep it really brief right

25 years in the muni bond landscape

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Too long if you talk to some people I

think what I love about municipal bonds

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is that I could drive anywhere with

my kids and point out projects that

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muni bonds have built whether they're

schools or libraries or hospitals

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or toll roads or bridges or stadiums

right It's all around us and I think

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that's what makes it super interesting

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Ryan: You know what, Eric?

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A couple things there.

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Thank you for that backdrop, but first

of all, with municipal bonds, I'm really

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glad you brought that up because and

we're gonna talk about it more in a

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little bit when you talk about investing,

it's hard to be like I invest in

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eric kazatsky: Yeah

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Ryan: What is that?

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What do I get for buying equity in

Apple or buying a bond in Apple,

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especially if you're teaching

kids how to invest, I'm big in the

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education, but if it's you know what?

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My money, I invested in that bond,

which helped build that stadium for

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that team, it's much more tangible.

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And we're gonna talk about that shortly.

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But another thing that

really caught my attention.

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With maka, you guys offer interval funds.

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Usually when we think of interval

funds, we're thinking of private credit.

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Is that what is wrapped up into

your interval funds or do you

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have municipals that are in

interval funds and that wrapper.

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eric kazatsky: Yeah no everything is

investment grade or high yield in the

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municipal space So no private credit no

BDCs anything like that in our interval

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funds specifically it's gonna lean more

towards investment grade and its nature

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And you know from a tax efficiency

standpoint you know we're trying to pass

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through losses make it as tax efficient

as possible and for investors in that

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fund they're getting those losses via

: 1099

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it's an interesting vehicle you're seeing

more of a demand for it these days as

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people are you know demanding more tax

efficiency you know in my mind the best

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mousetrap is probably still the co-mingled

mutual fund products shift in their

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popularity as we go through time right

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Ryan: Yeah.

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Perfect.

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Thank you for that.

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It was just interesting

that you brought up.

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Of funds, and most people

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eric kazatsky: Yeah

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Ryan: interval funds with private credit,

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eric kazatsky: Absolutely

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Ryan: eric, we cannot have this

conversation about fixed income without

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talking about the macro environment.

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Lot to unpack there on the

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macro environment and the impact

it has on inflation rates, you

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eric kazatsky: Yeah

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Ryan: So let's start there.

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Investors are faced with

a lot of uncertainties.

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We have the Orion conflict or war oil

prices, cracks in the labor market.

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New fed chair, we could have

a whole conversation on this.

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Eric, can you provide us with a little

overview of the primary macro drivers

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right now that you're watching?

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eric kazatsky: I think you hit on all

the things that we're watching that we

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weren't watching to start the year None of

this was on any strategist's radar except

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for the fact that inflation was still a

little sticky coming into the start of

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this year But I think that this is the

environment where municipals really shine

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They're an uncorrelated asset class You

know when I say that they have different

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behavioral characteristics in a higher

volatility environment to the benefit of

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investors They're zigging when other asset

classes are zagging and that's what you

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want to balance the risk in any sort of

portfolio that has equities in other areas

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of fixed income but yes we are keeping

an eye on sort of the direction of rates

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although we tend to run our strategies as

duration neutral But you know as relative

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value managers we wanna be buying areas

of the curve that are continually the

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cheapest to have the best total return

possibilities So obviously the direction

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of rates and the steepness of the yield

curve are two things that factor into that

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Ryan: Yeah, no, you're exactly right.

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And it's a primary talking point

whenever you're talking about

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fixed income, the direction of

rates, the yield curve, whether

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eric kazatsky: Yeah

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Ryan: not gonna, I'm not in the

position to predict or even want

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to predict where those are going.

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eric kazatsky: Exactly But look I think

the things that we have in our you know

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front window looking forward over the next

several months is just being in a more

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defensive posture playing with structure

and that's what makes the muni market so

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great that it has convexity and structure

that you could pull different levers

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than you can in just corporate world

for instance you know from a couponing

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standpoint you know we were selling you

know smaller coupons at the end of last

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year and the beginning of this year and

buying higher coupons more defensive in

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a higher rate environment Obviously we

didn't know where rates were gonna go

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coming into this year with the volatility

but it proved to be the right move

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Ryan: Yeah, exactly.

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And we're gonna talk shortly

about the impact municipals

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have on an investment portfolio.

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You talked about increased

diversification, that lower correlation,

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which as we know is very important.

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But let's talk real quick, continue

this yield curve discussion.

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You talked about your very.

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Duration neutral.

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And so is there a certain part of

the yield curve that you and your

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team believe is most attractive?

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Or do you just go across

the whole yield curve?

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Is that something you don't really play

into since you're, more duration neutral?

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eric kazatsky: So we do top five insights

each and every December comes out in

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the beginning of January and it's really

a guidepost for what we're thinking

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about our portfolios you know across

the spectrum for the following year And

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a second insight this year was really

focused on where on the yield curve we

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thought that the most relative value was

And that really for us was you know a

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little bit longer between 17 to 22 years

on the curve it's where the yield curve

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on the municipal side is the steepest

So you're getting the most rolled down

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most income coming into portfolios but

on a ratio basis which is how munis are

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often looked at from a value standpoint

they tend to have the highest ratios

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meaning they're the cheapest so for us

it continues to be a higher conviction

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idea and it's interesting You see a lot

of the fund flows coming into our space

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aggregating in 10 years and in on the

curve and they're distorting the value

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there which you know in our opinion

makes the long end even more attractive

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Ryan: So how does, I was gonna ask,

you set those viewpoints at the

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beginning of the year, like you

said, at the beginning of the year.

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We didn't have the issues

that we have today.

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eric kazatsky: Absolutely

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Ryan: in, five months in, how did

geopolitical issues impact municipals

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as much as like they might just impact

credit or obviously treasuries and

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governments, are they a little bit more

shielded from the geopolitical chaos?

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eric kazatsky: Yeah because we're a

domestic based product right So they have

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their own issues to contend with And when

I speak about those issues in particular

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you have the pandemic money rolling off

state and local government balance sheets

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you have you know cuts to federal funding

trickling down to the local level you

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have the tax bill that was passed last

year that you know on the margin impacted

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you know some areas of healthcare and you

just have shifts in value proposition of

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the higher ed model in general So munis

definitely have their own sort of issues

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that they're dealing with domestically

but they are at the end of the day you

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know directionally pulled by the treasury

market and where that's going which is

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influenced you know by geopolitical issues

you know we don't move on a one-to-one

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basis but directionally we tend to follow

just maybe on a lag basis or you know

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where we tend to be a little bit ahead

of them I think that again that's the

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beauty of the muni market is that to some

degree we march to our own drum we're the

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treasury market with a credit component

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Ryan: Very good point.

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And like you, we said too, inflation's

a problem and inflation obviously is

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gonna impact all fixed income products.

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eric kazatsky: Yeah and I really think

it's inflation coupled with how the new

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Fed share when he finally you know takes

the reins is gonna tackle that problem you

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know you certainly came into the year with

the expectation of several cuts and then

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that went away pretty quickly but you know

I think that the administration's current

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focus is to try and get interest rate

costs lower right Roll over treasuries

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in a lower rate environment also make

having housing more affordable but I think

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there is generally a misunderstanding

that the administration wants you know

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more compressed housing spreads and

they conflate that with interest rate

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costs So you know they have a couple

problems that they need to solve this year

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Ryan: Very good point, Eric.

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So talk, focus more on Munis here.

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Why do you think they're attractive and

they're an attractive investment given

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this current macro environment that we're

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eric kazatsky: Yeah

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Ryan: with?

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eric kazatsky: I mean you highlighted it

that there's the lack of correlation the

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diversity in a portfolio you know take

taxable munis for instance If perfect

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satellite addition to someone who's

running a core plus strategy you know

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if you do a bolt-on edition of taxable

muni sleeve if you're bringing down

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the standard deviation of risk across

that account and that's really what you

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wanna do from a portfolio management

standpoint and add alpha along the way

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right Because you are getting a little

bit more spread for the taxable munis

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than you are on the corporate side and

in a low spread environment that's always

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a positive I do think munis you know we

know how they behave in you know down

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economic cycles We have a guidepost you

know obviously: 2020

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know they tend to rally pretty strong

following those downturns So again we have

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a playbook at hand for forward performance

and it's you know looking pretty good

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Ryan: Yeah, great.

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They're, the benefits.

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Correlation.

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Real quickly, let's go back and

all over the place here, Erica,

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I have so much to comment on, but

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eric kazatsky: Great

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Ryan: There's taxable

munis and tax-free munis.

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eric kazatsky: Correct

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Ryan: think a lot of people forget about.

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There's taxable munis and maybe some of

the benefits they offer, and we always

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just focus on the tax free benefits of

Munis, which obviously is very important.

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there's other benefits to the taxable.

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eric kazatsky: I have five minutes with

an advisor and their question is what do

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you love the most this year What are your

best ideas I'm coming at them with two of

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the products that we have that are just

very unique One is you know our insured

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Ryan: I.

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eric kazatsky: bond ETF because we see

a lot of value in insurance on the you

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know as part of that wrapper but I'm

also talking to them about our taxable

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muni fund and they're inevitably the

question comes up why do these even exist

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And obviously it's a function of tax law

right There are a lot of issuers in the

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municipal space who wanna do financing

that just doesn't pass the sniff test with

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the IRS to have tax exemption And so a

lot of those issues fall into the taxable

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muni side of the market And some of those

issuers are pretty large household names

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right Like the Harvards of the world

Duke Universities Stanford University

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large healthcare systems in a multi-state

scenario where you have the willingness of

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non-traditional buyers to do credit work

there You know you're not really talking

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about a $10 million school district

deal in the middle of Pennsylvania You

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know I think that they almost have an

institutional like attraction there

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because of the size and that has really

helped with adoption of that side of

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the market in the last several years

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Ryan: Because I'll be honest with Jerry

I'm a, I often forget about it too.

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And the

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eric kazatsky: Yeah

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Ryan: when?

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eric kazatsky: don't blame you Most do

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Ryan: Okay, good.

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So I'm not the

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eric kazatsky: Yeah

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Ryan: I'm not the only one that.

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eric kazatsky: A lot of the questions

we get are why do these even exist And

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I'm like It's a fair question so we

walk them through you know why taxable

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munies exist and what the benefits

are Look you're getting all of the

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benefits of the credit side of the

muni market right That low correlation

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very statistically low historical

default rate just in a taxable wrapper

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Ryan: fantastic.

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We've talked already about

the benefits of Munis, right?

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Correlation, whether it's part

of the portfolio, investment

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portfolio, the role they play.

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But also in terms of just

the macro environment.

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So why do you believe munis

are often forgotten about?

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Whenever we think fixed

income, we think high yield.

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We think credit.

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We think governments now

even emerging market debt.

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Why do we forget about Munis?

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eric kazatsky: Because Sleep At Night

really isn't sexy for a lot of people

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right And at the end of the day you have

a lot of investment options that are

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generating fixed income especially on

the private side of the fence or on the

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alternative investment platforms that

have very high yields But I remember when

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I was starting off my career you know

we had a strategist on our desk who was

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wrote a piece and it was basically there's

no such thing as a free launch And it's

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really true in fixed income You cannot

have 10 11 12 yields without taking on

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some model of risk And so I think that you

know if you're willing to look optically

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at what munis are that safe portion of

your portfolio where you can get very

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attractive tax equivalent yields right

now given where absolute rates are they

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make a lot of sense I think it's just

bringing them to investors attention

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I'll give you a perfect example right

The New York City general obligation bond

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priced about two or three weeks ago at

this point but if you were a Manhattan

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resident so you're talking the highest

tax rate in the state and then the city

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tax on top of it close to a 55 all in

rate if you bought bonds in the long end

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of that curve you were probably close

to a 10 tax equivalent yield Now think

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about the equivalent risk you'd have to

take outside of the muni market to get

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something for 10 I you know that's the

conversations we're having a lot more of

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Ryan: Yeah, that's a great example because

I think when you throw numbers at it like

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that and you put the taxable equivalent,

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Rate on their yield,

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eric kazatsky: Yeah Grant not

everyone's in a 55 bracket so that

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Ryan: Yeah.

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eric kazatsky: We have a lot of

clients that are in high tax enclaves

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right Whether New Jersey Connecticut

New York or California you know

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those tax bills are getting up there

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Ryan: Yeah it's almost like it,

we talk a lot on the equity side.

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It's those blue chips, those

high dividend, high yielding,

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Stocks, equities, they're boring.

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They're not sexy compared to the AI

shoot, to the moon stuff, but they play

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a very important role when you're talking

about the construction of a portfolio.

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eric kazatsky: Look and here's something I

think that's underappreciated too right If

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you just take the tax equivalent yield of

municipals and measure them along with the

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dividend yield of the S&P 500 munis win

by a pretty wide margin So you know take

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capital appreciation out of the question

because we don't know what that path looks

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like for equities or munis just income

to income munis are the better investment

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right now to generate income on a basis

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Ryan: Yeah, for sure.

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So we talked a little bit about

duration earlier, and obviously whenever

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you're talking fixed income, you have

to talk about interest rate, risk,

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and volatility there for financial

advisors who might be concerned about.

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Interest rate volatility and the risk

that comes along with interest rates.

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Can munis be a little duration

played too, or how do they

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react to interest rate moves?

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Are they a little bit more muted

and not as sensitive as credit?

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eric kazatsky: It really depends on what

sort of wrapper they're in right you

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know at the end of the day municipals are

still a retail driven market and there's

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some emotionality involved in that You

know that's why when you look across

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the offerings that we have you know our

limited partnerships you know they're

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structured in a way where we take the

emotionality out of the equation because

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we have this differential liquidity

structure where you know we don't have

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to be meeting intraday or end of day sort

of liquidity needs So let's say you have

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a situation where you know you had the

tariff tantrum in spring of: 2025

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was a lot of knee-jerk reaction from the

rates market some sort of unnecessary

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selling from the muni side following that

you know those funds were a little bit

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more insulated You know whenever you have

high volatility moves you know you tend to

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you know gonna move in the same direction

as treasuries you know So to say they're

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completely insulated no they don't move

as sharply in either direction And I think

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that especially where rates are right

now I think there's only so wide that

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spreads are gonna get on the muni side

or so high yields are gonna get before

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you really have crossover buyers you know

those non-traditional buyers munis come

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in and look to do more differentiated

investing for their portfolios

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Ryan: Eric, that's great.

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So with Muni, I do a lot of research

and Zephyr, because that it's not

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as big now, but the active versus

passive debate, where can you.

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Get some asset especially

on the equity side.

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Are there asset classes where it's better

just to go passive and save some money?

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: 00:18:43

Obviously large core, for fixed income,

I'm a firm believer you should go active.

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Like I said before, there's

the fixed income space

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eric kazatsky: Yeah

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Ryan: vast.

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Is that the same with Muni too?

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Do you feel like you're better

off taking an active approach?

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Because if you take passive.

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Yeah, maybe you're saving some fees

on the expense ratio, but at the same

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time, there's so many elements the

muni world and fixed income space that

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you wanna take an active approach to.

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eric kazatsky: You just said it

perfectly I'm gonna take you on

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my client calls over the next

several weeks you can help me make

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Ryan: not, Eric.

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: 00:19:19

I'm not gonna win you any deals.

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: 00:19:22

eric kazatsky: yeah I mean look we're

an actively managed shop so you know

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: 00:19:25

self-serving commentary aside I do

believe that especially in a an area

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like municipals where we have you know

50,000 different issuers you know a

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active approach where you're looking at

value on the curve and pairing that with

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better credit selection is really the way

to play that market and it's proven over

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time right Now look that's not to say

that passive strategies and cheap beta

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: 00:19:50

options you know don't have suitability

in portfolios and I understand the

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attractiveness of getting muni exposure

at three basis points Totally understand

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: 00:19:59

it But again you know if you wanna you

know have the best shot at outreturning

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: 00:20:04

where inflation is or where it's heading

you know pair that cheap beta exposure

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: 00:20:08

with an active strategy as well right And

you get the best of both worlds A perfect

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: 00:20:13

example when you talk about diversity

is a lot of these large ETF aggregators

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: 00:20:18

that are passive they don't invest in

the entirety of the market but they're

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: 00:20:21

really marketed as the SPY equivalent

of the muni space But if you look under

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: 00:20:26

the hood you're probably missing like

30 of the market And for us it's that

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30 where we're finding a lot of alpha

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: 00:20:34

Ryan: Yeah.

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: 00:20:34

I'll be honest with you, on the muni

market, I don't do a, haven't done a lot

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: 00:20:37

of research in terms of these indexes.

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: 00:20:40

And what their

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: 00:20:41

Are.

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: 00:20:41

But like with the egg,

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: 00:20:44

eric kazatsky: Yeah

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: 00:20:44

Ryan: egg is, if you just go

passive, the egg, ETF, getting a

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: 00:20:50

huge amount of treasuries in there.

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: 00:20:53

Do you

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: 00:20:54

want that in your core portfolio?

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: 00:20:57

eric kazatsky: Yeah so look in the

Bloomberg ag right there is a small slice

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under the other industrial sub-bucket

that actually has a little bit of

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: 00:21:05

taxable muni in there Most people don't

know that So even if you just have beta

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: 00:21:08

exposure you already have a little bit

of taxable media exposure but I think

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: 00:21:12

like the things that are interesting if

you're just looking at just trying to

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replicate the ag is that you do have a

lot of treasuries and you have a lot of

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: 00:21:18

securitized product that if rates do shoot

down you know all of that's gonna get

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: 00:21:22

refied right And you have some repricing

risk built in there again you know taxable

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: 00:21:27

immunities make sense to bolt on there

because they're a little bit longer in

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: 00:21:30

duration so you know you take some of

that element of uncertainty out of there

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: 00:21:35

Ryan: Awesome, Eric.

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: 00:21:36

Lastly, let's bring back to financial

advisors and client portfolios for them.

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: 00:21:43

Even though munis have been

around for, centuries and stuff

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: 00:21:47

and part of investment portfolios

there can be often forgot about.

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: 00:21:51

How should financial advisors

think of Munis within a portfolio?

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: 00:21:54

Should they just be

income producing asset or

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: 00:21:57

eric kazatsky: Yeah

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: 00:21:58

Ryan: like you say, capital preservation?

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: 00:22:01

How should they view

municipals within a portfolio?

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: 00:22:05

eric kazatsky: I think they should be

viewed at as an income producing asset

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: 00:22:08

with a total return upside right And

that's really what active management

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: 00:22:12

brings to the table you know on our

alternative investment platform with our

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: 00:22:16

limited partnerships you we're trying to

beat those blended benchmarks by 150 to

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: 00:22:19

200 basis points each and every year We're

setting the bar high for outperformance

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: 00:22:24

as well as delivering a tax exempt

income stream that on a tax equivalent

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: 00:22:29

basis is very attractive right That's

what they need to be thinking about in

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: 00:22:32

addition to the diversity that it brings

to the entire client investment portfolio

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: 00:22:39

Ryan: Wow.

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: 00:22:40

Awesome conversation, great insight

on, like I said, a space that I

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: 00:22:45

think should get more attention, more

eyes, more headlines and municipals.

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: 00:22:50

I'm sure you do too,

and the folks at mackay.

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: 00:22:53

But insight.

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: 00:22:54

I'm really glad you came on.

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: 00:22:56

It's been an honor.

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: 00:22:57

Where can our audience

get more information about

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: 00:23:00

mackay Municipal Managers?

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: 00:23:02

eric kazatsky: Absolutely So

our website you can go on either

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: 00:23:06

through the New York Life Investment

Management Portal or Muni360

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: 00:23:11

360.com

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: 00:23:12

And we publish a lot of insights and

thought leadership pieces We do a weekly

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: 00:23:16

that comes out every Tuesday all our

media pieces So everything that you wanna

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: 00:23:20

find out about the franchise or you know

get an insight of what we're thinking

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: 00:23:23

and most up to date is gonna be on there

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: 00:23:26

Ryan: Yeah.

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: 00:23:26

Eric, a lot of people

may not realize this.

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: 00:23:29

I do a little bit of research

before I jump on these calls.

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: 00:23:33

I go

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: 00:23:33

eric kazatsky: Yeah

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: 00:23:33

Ryan: websites, mackay.

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: 00:23:34

You guys do a lot of great

information there, content research.

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: 00:23:39

So for anyone who's looking

for information on municipals.

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: 00:23:44

Can't recommend it enough.

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: 00:23:46

Great stuff there.

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: 00:23:47

eric kazatsky: Appreciate that Yeah

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: 00:23:49

Ryan: you for coming on and thank you

everyone for listening to this episode

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: 00:23:52

is zephyr's Adjusted for Risk podcast.

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: 00:23:55

You can watch all of our other episodes

on the Zephyr YouTube channel, as

410

: 00:23:59

well as on Spotify and wherever else

you catch your favorite podcast.

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: 00:24:04

Thank you very much and have

a great rest of your week.