A Mystery in the High-Yield Muni Market: What Are the Riskiest Bonds Worth?
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Junk-bond prices are ‘written in pencil, not pen’
When a tiny mutual fund dumped bonds recently, the low prices it got affirmed an alarming reality for investors in risky municipal debt: Many securities turn out to be worth less than shareholders have been told.
Shares of Easterly Asset Management’s high-yield muni fund in early June cost about $6, based on Easterly’s estimated value for each bond in the fund. But many of those bonds hadn’t traded in years. And when Easterly began rapidly selling some last month, buyers weren’t willing to pay nearly the amount fund managers had estimated.
An Easterly spokeswoman said true price discovery is only possible when bonds trade in the market.
Following the sales, the Easterly fund’s share price tumbled to around $3. That is a startling move—even for junk debt—in the relatively staid world of muni bonds, the debt of state and local governments. Investors generally prize munis for their stability and frequently tax-free interest payments. Easterly’s experience left some asking how many more rude awakenings that market will have.
Many deals in the $400 billion muni junk-bond market date to a time when money flowed so freely that investors bought up parody cryptocoins and a Reddit-fueled GameStop-buying spree caused trading halts at the New York Stock Exchange. Now investors in high-yield muni funds face the question of what in their portfolio belongs to that class of highflying investments—and how bad the fallout will be.
A popular bet…
Ownership of high-yield muni funds is at near-record levels, according to LSEG data. Investors flush with market gains piled back into low-rated and unrated muni bonds last year, after steering clear while rates were climbing.
…from an earlier time
The funds’ truly explosive growth, however, occurred from about 2016 to 2021, when an unprecedented wave of investor cash fueled a prepandemic borrowing frenzy. Fund managers with piles of cash to put to work financed all manner of projects.
Some weren’t ready for prime time. Artifacts from that era include a default-plagued New Jersey megamall with an indoor ski slope and a 280-acre Arizona sports park developed by a father-son team who this spring pleaded guilty to fraud and identity theft.
Billions of dollars worth of such shaky one-off projects now sit in high-yield muni funds. Managers in offices hundreds of miles away from the projects are left with the tricky task of deciding what value to assign to their bonds. All they have to rely on sometimes are long-ago trades, price data from industry bond-evaluation services and their own research. There is plenty of room for disagreement.
Questions in Texas
A Texas bond from Easterly’s portfolio is a good example. The Buckingham, a luxury senior-living community in Houston, has been struggling financially for years. Since 2023, the bond has been trading—in relatively small quantities—at 12 cents on the dollar or less.
But mutual-fund managers Nuveen and Invesco assigned a significantly higher value to the bond when they last reported their high-yield fund holdings on May 31. The two funds valued it at 35 cents and 36 cents on the dollar, respectively, according to a Journal analysis of Morningstar Direct data. Last month, the bonds’ biggest trade in years—about $11 million—priced it at about 7 cents.
A Nuveen spokeswoman said the firm’s valuation of the Buckingham bond is based on information only available to investors involved in a debt restructuring. Nuveen is known for maximizing recoveries in distressed situations, the spokeswoman said.
Other bonds Nuveen and Invesco had in common with Easterly traded at 20 or more cents lower than where fund managers had valued them. Those managers’ high-yield funds are so big and diversified, though, that any hit to their share price is likely to be imperceptible.
Different challenges
Not all muni junk bonds are so hard to price. Distressed city and county bonds trade frequently and are backed by taxes and monitored by ratings firms. But many high-yield muni bonds finance one-off projects whose organizers plan to repay bondholders with the money they expect to make. Local government officials allow such projects to sell munis based on the idea that they could aid economic development or some other public good. The bonds are often held by just a few asset managers and frequently go years without trading.
Funds full of hard-to-trade junk bonds sometimes have to make quick moves to stay compliant with federal securities rules aimed at ensuring sufficient liquidity. A common reason for fire sales like Easterly’s is to avoid running afoul of those regulations.
Returns have lagged behind for both junk and high-grade munis recently. States and cities running low on cash borrowed heavily over the past two years, pumping up supply. President Trump’s tariff broadside walloped the overall bond market. Then this month prices plummeted for a multibillion-dollar high-yield project—a trainline through Florida—after it said it was deferring an interest payment.
High-yield muni mutual-fund shareholders might not always realize how much art—rather than science—goes into pricing some high-yield bonds, said Matt Fabian, a partner at research firm Municipal Market Analytics. Mutual funds update their share prices daily.
“The prices that individual investors get on their muni-bond account statement are good approximations,” he said. “But you have to think about those as written in pencil, not pen. You only have a very rough idea of what they might be worth.”