Talk Your Book: Investing in High Yield Munis
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Today's Animal Spirits Talk Your Book is brought to you by Nuveen. Go to nuveen.com to learn more about the Nuveen Enhanced High Yield Municipal Bond Fund. That's ticker NMSSX. We'll talk about it on the show today. That's nuveen.com to learn more.

Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

Welcome to Animal Spirits with Michael and Ben. Michael, one of the themes on our Talk Your Book segments that I've come to realize is that there are more corners of the market, especially in the credit space, than I think most people realize. Great thing. There's a lot of different ways to finance projects, businesses, investments than you realize. And this is one of those spaces. So Nuveen has this high-yield muni bond fund.

And it's an interval fund because these are relatively illiquid securities. But it makes sense and they're muni bonds that fund these projects. These projects are sort of uncertain. So that's what makes them, they don't, these bonds don't trade very much, but there's just so many corners of the credit market that like, I think a lot of people don't even realize exist. That's right, Ben. So this is one of those conversations where

A lot of new things for Ben and I, a lot we didn't know. So I hope you enjoy our conversation with Steve Lavin from Niveen. Steve, welcome to Animal Spirits. Thank you very much. It's a pleasure to be here. Okay, so you are a high-yield municipal bond manager. And I have a question just about municipalities in the whole, and then we can kind of drill down into the strategy. But you obviously remember the Meredith Whitney prediction that all these municipalities were going to go bankrupt back in the 2010s, and it was a big story, and it got people all worried.

My understanding is, because of all the fiscal support sent out during the pandemic, that a lot of municipalities are in much better shape than they were back then because of this. Is that a true reading of the situation? Yeah, it's true. And then there's more to the story. In hindsight, a lot of that stimulus was unnecessary because the expected rate

massive contractions in tax revenue collections didn't occur. Actually, the contrary happened. We had huge increases in sales tax revenues while income revenues and property tax revenues continued to grow on top of that. So when the dust settled, state and local governments were in the strongest position they had been really in recorded municipal bond history. The story in the market this year

And to a lesser extent every year, but certainly this year is the deficit and its impact on treasury issuance and rates are moving higher with that. I'm curious to learn more about the municipal bond market. How are cities compared to the federal government? Like, are they funded? Are they running severe deficits? What does that look like?

The big difference between state and local governments versus the federal government is that they cannot deficit finance themselves. They have to balance their budgets. You don't see large surges of municipal bond issuance just because

there are growing budget deficits. I mean, that just doesn't happen. I mean, they can run deficits, but then they have to balance that with rainy day funds or increase revenues on the other side eventually, right? They just cannot grow and grow and grow because they can't print their own money. And so while the municipal bond market is positively correlated to treasury yields, there are a lot of other technical factors that impact municipal bond yields. Such as?

primarily fund flows and issuance. So for example, this year, we are seeing a continuation of record issuance. So therefore, in the first quarter of 2025, the municipal bond market was the worst performing fixed income asset class, even over and above what was happening to the treasury yield pressure. And that was because of a huge surge of supply.

Why is there so much supply given where rates are? Is that just because, I mean, obviously they would prefer to not issue a new paper at these levels, but I'm guessing they have no choice in the matter. Yeah, there is somewhat of a no choice in the matter effect here because a lot of this is project financing.

And projects just cost more. If you just consider the cumulative run-up in inflation since inflation started to increase coming out of COVID, it just costs more to build. And so you think about just the cumulative run-up in CPI is a little bit more than 25%. A 25% increase in supply is not substantial.

surprising under that context. But then there are other factors, policy factors. And so even the rhetoric or the rumors of possibly limiting or eliminating the tax exemption has pulled a lot of supply forward. And there's also fears that rates might continue to rise further in the future from Treasury pressure.

And so a lot of dealers and bankers are encouraging their issuers to get to market sooner. So there's just this pull forward.

and a lot of supply. Obviously, that will balance itself out as we get into the later stage of the year. But at this point, we are running at another record pace of issuance, even over and above last year, which was a record number of issuance. Michael is more of a gambler than me, so he likes to speak in odds a lot of times. So if you had to put that idea of they're going to do away with taxes and status in the municipals

my thinking would be that's a very low probability event. You'd have to give me a plus 1,000 or something on that to make that worth the bet. Is that a pretty low probability?

probability outcome for you as well? Yeah. And the odds just fell considerably. I mean, the odds were already very, very low and the odds fell considerably when the first draft of the big, beautiful bill came forward. There is no mention of that. It was just the idea that in the past, when we're talking about covering large deficits in a new tax bill, oftentimes they do throw the muni exemption in there as a starting point and then it's been taken out. But in this case, it wasn't even in there to start.

So high yield municipal bonds, what are we looking at? What does that opportunity set look like? Um,

What sort of coverage ratios? Well, I guess you said these are fully funded, but what makes something high yield? Is this like sketchy neighborhoods or what exactly? Yeah. I mean, that's the misconception often held is that when you say high yield municipal, you think of a sketchy, below investment grade local government.

But what we are really talking about are infrastructure project revenue bonds. And what we really should be calling them are U.S. infrastructure bonds. That's a much better brand. You should do that. Right. Totally. We love that word. It's infrastructure. It's U.S. And the ironic thing here is that with all this talk about tariffs and repatriating manufacturing and industry,

Fundamentally speaking, high-yield municipals, which funds the majority of our nation's infrastructure, should be a large beneficiary. But yet...

We're seeing that tariff volatility spill over into our market from a technical standpoint. So going back to the main theme here, high-yield municipal bonds are project revenue bonds. They have some common features to them. One, they typically are financing the construction and then the operation of a new infrastructure project. And they vary across a lot of sectors, healthcare, education, utilities, transportation, land development.

individual site project development, and then they should, under best underwriting practices, be secured by the underlying collateral, the physical project itself, the land, the property, the building, etc. And then the bonds are secured by a dedicated revenue stream associated with that specific project.

Now, sometimes these projects can have the backing of a state and local government kind of as a security backstop. But your ultimate risk here is in the construction of the project. Will it be built on time and as designed? No cost overruns.

Will it be turned on? So you have to go through a ramp-up period. And then is it going to be used over the life of the bonds? So you have construction risk, ramp-up risk, and operational risk. But as you resolve those three phases of risks, then you can progress a high-yield, below-investment-grade bond closer to that investment-grade category. And then the bonds are typically called. Most successful high-yield mini bonds do not last until their stated maturities. Oftentimes, they are called because of the success rate

of building it, turning it on, and operating it. So what is the feature that makes these high yield or below investment grade? Like, what is the reason for it? Is it just because of the nature of these projects that they're uncertain? Yeah, at start, they're speculative. So at the very beginning, oftentimes what you're dealing with is a plot of dirt.

So you issue the bonds to build the infrastructure piece. And so it is speculative. There is no certainty that the project can be built. There is no certainty that it will ramp up. And there's no certainty that there will be utilization to service the bonds. But as the project progresses in its life cycle, those risks get either partially or fully resolved. I'm looking at your website, and there's a lot of...

I like what you're doing here. I like what you're doing here. You've got the maturity breakdown. You've got top states and territories, sector allocation, credit quality. Credit to you guys. Very well done on the visuals here. Thank you. What stands out to me, and there's a few things, but I'll start with this. Almost 84% of the portfolio as of the end of April 2025 are not rated. What does a not rated municipal bond look like? Why are they not rated? I don't know. This is a bit foreign to me.

Yeah, and it oftentimes appears that way to folks that aren't inside the baseball game. And the reality is that- Oh, I'm in the game. No, I'm just kidding. I'm not. Go on in. The water's warm. Non-rated is the heart and soul of the high-yield mini market. The reality is that the vast majority of the existing high-yield mini market is non-rated.

If you look at just the trailing last three years, over 80% of all new issuance has come non-rated. It's just inherently what the market is. And so why? Well, most high yield mini issuances are small to medium size. Obviously, there's the big blockbuster deals, the billion dollar plus deals. There's several of them throughout the year. But your typical high yield mini bond issuance is going to fall into that $500 to $200 million range.

It's going to be, as I said, speculative in nature, so it doesn't have a chance to get an investment grade anyway. And you're selling to institutions. You're not selling high-yield muni bonds to retail that need the public coverage. They need the public rating. They need someone to do research for them. Institutions should be doing their own independent research. And so why pay for a rating? Why? Why?

And so a lot of issuers just don't choose to go out and say, oh, well, I'm going to pay a fixed amount of cost. It's going to drive up my borrowing costs, and I'm going to get a B minus rating anyway. Is there a size component where it's over a certain dollar amount or, I guess, under a certain dollar amount that just doesn't make sense because it would be prohibitively expensive? Yeah. I mean, it's obviously the discretion of the issuer, but...

There's a fixed amount cost to getting a rating. Usually, it's several hundred thousand dollars. And so why pay that when all it's going to do is lower the economies and your project?

Even large issuers oftentimes do come non-rated because they're too complicated. That's the other part of the reason why there are non-rated bonds is that you got to fit inside a box for a public rating agency. You have to fit inside a methodology. And I'll use World Trade Center for an example because everyone knows that project, right? Municipal bonds finance the construction.

and the lease-up period of World Trade Center number three. And it did not get a rating from the rating agencies because at that time the bonds were issued, there was construction risk and lease-up risk. And the rating agencies had a model for either or, not both. They didn't have a hybrid model. And so therefore, it was non-rated. And so oftentimes, these structures are just too complicated. And they don't fit inside the established methodologies.

So what kind of spread are we looking at here in high yields? Or what type of spread are you looking for in your portfolio over other higher-rated munis or the 10-year, I guess? Yeah, I mean, the average high-yield muni spreads are just inside 200 basis points right now. And to someone who has...

More experienced in the high-yield corporate market, you're like, oh, that's really tight. Well, high-yield is- Yeah, I was going to say, that doesn't seem like a lot of juice. Yeah, right? It's not compared to the high-yield corporate market. And the reason, there's a lot of reasons why, but the basic explanation is that there's not as much risk.

If you just look at default risk historically, high-yield munis default substantially less than high-yield corporates. I mean, Moody's has the longest historical default study out there. They look at everything they've rated going back to 1970. And if you just kind of take the midpoint, right, that double B category of high yield, high-yield municipals have an average 10-year cumulative default rate that's about 20%.

of the same rated high-yield corporates. And then on top of that, the recovery values are substantially higher within that category. So there's just less risk.

And there's better collateral involved. So at 200 basis points, that's kind of around the historical midpoint. Now, you can get higher. Like when you look at COVID, for example, or if you look at the summer of 2013, both of these periods when you have a lot of big outflows and cause spreads to blow out, you can get 300, 350 basis points. And it's usually where it caps off is in that mid-300 basis points.

Because at that level, you're starting to talk about tax equivalent yields that are now going to start competing with high-yield corporates. That's that other piece of it is that that tax exemption kind of keeps a ceiling on how high spreads can get in our space. It can get a lot tighter. So the historical tights, if you go back to like the early 2000s, you go to the, you know,

the credit bonanza of 2007, or even if you get into the summer of 2016 when things were really tight, you can get around plus 100 basis points on average. So we're kind of in that midpoint right now. And I would argue that spread should be a lot tighter just given the strength of high-yield muni credit currently.

Uh, I'm looking at the top States and top States and territories. And Colorado is number one as of the end of April, 2025, it was 18%. What's going on there? Weed farm infrastructure. Yeah. Uh,

Well, look, I mean, the top states, right? Colorado, Florida, Texas, right? Are right up there. And Wisconsin. And so Wisconsin, let's put that aside for a second. Okay, we'll hold Wisconsin aside. That's very misleading, but we'll explain it. But the three states to pick on right now are Colorado, Texas, and Florida. So what do those three states have in common, right? Population growth, demand for infrastructure, right?

And so that explains that. We don't have a top-down view where we say, oh, let's go buy a bunch of projects in the States. Those overweights are a byproduct of cumulative credit selection opportunities because we're finding more infrastructure demand and more infrastructure development

in those particular states. And so what are they, right? Well, it's land and community development. It's education, primarily charter schools. Charter schools are very necessary when you have strong population growth, strong home formation, because it puts a lot of pressure on the public school system. And charter schools play a very important release valve in those dynamics. And then also transportation and health care.

So when you take those four sectors, that explains the vast majority of those overweights. So because a lot of these bonds are not rated, is that one of these things where it's an overlooked sector? Maybe this is a softball question for you, but it seems like a lot of, I'm guessing a lot of...

family offices or certain investors maybe have guidelines where they can't own non-rated bonds. Does that make it easier for you as an investor to pick through the winners and losers? Yeah, a lot of independents do have those restrictions. I mean, for example, I mean, we have some institutional accounts where there are restrictions just like that, right? They want to, they want to see and, and, and, and have transparency in what they own. So therefore the non-rated space is, is naturally inefficient, right? Everyone's going to have a difference in opinion and,

on what a credit rating should be and why. And therefore, there should be differences in opinion on what that bond is worth, what the spread should be worth, what the yield should be worth, price, obviously. And so to operate effectively in this space, you have to be able to do your own research. Independent research is critical.

We have 25 dedicated municipal bond research analysts. The average years of experience is 20 years. They're all sector specialists. They will follow these issuers for their entire career. They get to know them better than the operators. For example, we have some hospital analysts that have followed credits and they have seen CFOs come and go over and over and over and they just know the hospital better than they do. It's all about independent research.

And even within the peer group, you see huge variations in terms of the size and the dedication and the experience of research staff, even within the high yield meaning fund manager space. How long do these projects take to complete? Because I'm looking at the maturity breakdown and it's a lot of years.

Yeah, it is a lot of years. These are long-dated assets, and so it's long-dated debt. So you just think about the asset liability matching that's required. These are long-dated assets. The bonds are designed to be paid by these revenue streams that can be stretched out of the useful life of the project. But as I said earlier, the reality is that bonds don't usually last until they're stated maturity. Most high-albuminy bonds have...

have features like sinking funds, mandatory turbo redemptions, and call options. So does the duration of your fund end up being a lot lower than the maturity profile then? Yes. Yes. So if you look at a high yield muni bond, it's pretty typical. If they have like an average maturity of 20 years, the duration is going to be closer to like 10, 12.

There's just a lot of optionality. So option adjusted statistics are very important. You think about high yield meaning, you think credit, there's a lot of quant that goes into high yield meaning bonds. There's just so many structural features.

and high-yield mini bonds that make valuation opportunities even more prevalent in our space. So it's not just about credit. Sorry, sorry to cut you off. And these municipalities obviously want to pay them off earlier. Yes. So they want the optionality, right? Because if they can build it and they can ramp it up and they can show that, hey, look, everyone's coming to our project. We're using it. We're getting debt service coverages of two plus times.

Then you can go to a rating agency and plead your case and say, give me an investment grade rating. Then you get your investment grade rating. You come to market, call your bonds and you refund. There's a lot of refunding opportunities in high yield mini markets. So there's a lot of negotiation that should go on. Not everyone has that type of pricing power, but when you do, you want to use it.

and make sure that not all the optionality is in the favor of the issuer, right? You want to wrestle some of that back and engineer some of your own positive convexity. So when we look at a high yield mini bond, we want to buy it at a discount on new issue. And we want to make sure that the call features take us out at a premium

And so you typically buy something kind of in the mid to high 90s, and you're typically taking out somewhere in the low to mid 10s, right? So like 103, 105 call is pretty common for the high-end bonds that we buy. Why would a bond trade at a discount when it's offered? It's part of the negotiation. It's what bondholders- Just to attract investors? Yeah, exactly. It's part of that-

negotiated deal process. Ben, if you look, you don't know the power of being bald. If you look like Steve and you come with a big pile of cash, you got favorable terms.

That's right. There's a lot of pricing power that you've got to throw around. And it's not just about size. It's about expertise. So having a research analyst is very important because they're not just looking at the deals as printed. They are talking to the bankers and the issuers weeks, if not months, before they come to market, kind of impressing upon them our best underwriting practices and saying, look, if you have these security features and this bond structure and this type of collateral package, we're

these are the best practices for this particular sector. You're going to increase the likelihood you're going to have a successful deal and you're

Underwriting risk goes down. The risk of the underwriters, they do it themselves. They come to market. No one shows up. And they promise their issuer, hey, we're going to get this deal done. Well, I'm going to take down all these bonds. And now I got to go sell them in the secondary market. So they want to know that they're going to have a successful deal. So negotiations for deal structure is really, really important in this space.

How much, I assume that these bonds that you're buying are being held to maturity. Obviously, some of them are being called away. So what does a turnover end up looking like in this fund? Yeah, there isn't a lot of turnover from our perspective, right? We are, first and foremost, long-term fundamental investors, right? But that doesn't mean we hold everything to maturity. There's still a lot of relative value opportunity in the secondary market. So the turnover is typically driven by two things.

Relative value swapping, swapping the inefficiencies in the market, selling something that we view too rich, buying something we see too cheap. I've obviously oversimplified it, but that's basically it.

And then there's a lot of tax efficiency management. So turnover can also be driven by what we call yield harvesting, where you're harvesting tax losses and rebooking at higher embedded yields for the portfolio that then can support the number one goal in a high-end union product, which is to maximize the level of tax-exempt income. I'm not going to lie. We've had clients in the past where it's hard to get them because it's essentially phantom income.

Right. That the tax savings are phantom income. So sometimes we have to show them the actual tax equivalent yield to make it make sense. Right. Right. And we we love to do that. It's eye popping when you're in an environment like like today. Right. You know, the average yield of the Barclays Bloomberg Highly Index right now is around a 580 percentile.

Obviously, active managers should be doing a lot more. Products like an interval fund can do that because they're better set up to take advantage of yield opportunities. But yes, you're pushing high single digits in terms of the taxable equivalent yield. And that's going to beat anything in the high-yield corporate market that's talking about a performing bond. And that's before you would even risk adjust it. Again, let's go back to our comments about the lower defaults and the higher recoveries. And with active management, you can really minimize that.

Steve, for people that want to learn more about the fund, what type of structure is it? So it's called an interval fund. We did not invent the term.

the machine we borrowed it. Interval funds have been out there for a while. But the whole concept of an interval fund is to provide interval liquidity. You can buy into it with daily subscriptions. It trades with a ticker. It has a daily NAV strike. It pays a monthly dividend. So from that standpoint, it looks and talks just like a mutual fund.

But you don't have access to daily liquidity. And this really gets down to the whole philosophical concept of the product, taking advantage of the expanding illiquidity premium in our market. And so it's not for everyone.

You know, interval funds do not offer daily liquidity. And so the investor has to consider that trade-off, right? I don't want or need all of my high yield muni exposure to be daily liquid. So why am I using a daily liquid product where that liquidity profile, the need to offer daily liquidity is a constraint?

So you give more of that illiquidity premium to us to deploy. That's the whole point. So the trade-off is that I will forego daily liquidity for quarterly liquidity. That's what you get in an interval fund. And with that, I should demand higher income, higher total returns, right? I am deploying more of that liquidity risk or illiquidity premium into the market. So is just, is the reason for that is just because these bonds are relatively illiquid, they don't trade all that often?

Liquidity risk is really important in our market. Even investment-grade munis, if you just look at the exact QSIPs, there's a very small fraction of muni bonds that trade on a daily basis. And that's even more so for high-yield muni. Liquidity is a finite thing. It is a discriminatory thing in our market. And liquidity has to be engineered. It has to be produced.

And so when you're trying to manage a product that needs daily liquidity, you have to actively produce that as a manager. And we'll fully admit that that is a constraint. It is an imposing mandate.

of maximizing income return. And so managing a daily liquid mutual fund is ultimately an optimization exercise, right? I've got these two mandates, maximize income and return, offer daily liquidity. If you can lessen that liquidity constraint, you can do more with the other mandate of maximizing income and return. I think there is a common...

misconception that high yield munis are eliquid. They're oftentimes just less liquid. They're liquid, but they're just less liquid. That liquidity has to be produced.

There are areas of the high yield mini market that are highly liquid, though. There are some non-rated high yield mini bonds that are as liquid as some investment grade paper. You look at the high beta areas of the high yield mini market, like tobacco securitization bonds or the restructured Puerto Rico bonds, not the defunct defaulted ones, but the new ones like the government bonds and the sales tax bonds. Those are highly liquid. And so the high beta areas of the market, you can trade vast sums in them.

Now, they can be really volatile from a spread standpoint, but they're still highly liquid. And there's a lot of non-rated bonds that are still liquid for us because there's enough comparisons out there. Observable comps is what you're looking for. And so say within the charter school sector,

You could have a charter school in Colorado that hasn't traded in a while, but there might have been several others in Colorado that were issued around the same time in the same area that offer comps to other market participants that helps make that other charter school that hasn't traded more liquid. So Steve, one of the things about this product that people need to understand is, I know we mentioned it briefly, but maybe just further clarification on the lack of liquidity.

Yes. The illiquidity premium and the muni market has been expanding since the financial crisis. If you just simply just look at the growing expansion of mutual fund assets under management, it has just been growing, growing, growing. At the same time, that ownership of municipal bonds by banks and dealers has been declining.

And so what that has done is it has created a larger supply demand imbalance. And so the market is balanced as long as mutual funds are liquid and getting inflows. But what happens when mutual funds started getting sizable outflows? The liquidity scale tips very quickly, and there's not a big enough buyer to go meet the size of liquidity demands that are now being produced by mutual funds. And so the muni market can easily get dislocated.

from technical pressures. It does. We've seen it. Yes. We just saw it on April 9th. The Enable Fund, to me, is a really interesting, vigilant response of the market. The market is challenging us to produce some type of solution, even a partial solution. And I think the Enable Fund does that. If you just think about

If all mutual funds in the muni market were integral funds, we wouldn't have weeks like April 9th. Right. But because we do, let's produce products that can take advantage of those things to make sure that they are just always cashflow positive and have ample time to produce liquidity when they need to. Right. Because this, this fund structure forces you to be a long-term investor. So you bet like that's the mindset going in. Absolutely. I think it's a better marriage of the investor and the investment.

We are investing in long-term projects. They have long-term bonds. And so using a bond that is tied to a long-term project that takes several years to build, to ramp up, to start operating, if you force liquidity on that thing when you're in the middle of those risk phases, you're going to be forced to take some illiquidity premium. You're going to have to because you're forcing uncertainty to be priced.

And so it is just, it is, it is a better marriage of the investor and what we're actually investing. All right, Steve, for people who want to learn more about this fund, where should we send them?

Go to our website, Nuvine.com. The ticker is NMSSX. Again, that's one of the benefits of an interval fund is it has a publicly traded ticker. It has daily transparency. And on the website, you can find the fact sheets. You can find the daily statistics. And you can also follow it on any Bloomberg tournament. Perfect. Thanks a lot, Steve. Thank you. Thank you.

All right. Thanks to Steve. Again, go to Naveen.com to learn more about this fund and email us at animalspiritsathecompoundnews.com. This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell, or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances underlying

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