The municipal bond market may not be as fast-moving as the equity or futures markets, but that doesn’t mean that investors should stop monitoring bonds after they are purchased. In addition to the handful of high-profile defaults, investors must be mindful of smaller changes in credit and liquidity risk that can impact how they build and maintain their overall portfolio.
Let’s take a look at why it’s important to monitor muni bonds and what metrics to watch.
Be sure to check our Education section to learn more about municipal bonds.
Why Monitor Muni Bonds?
Most investors do their due diligence before buying municipal bonds by assessing the financial health of the issuer and the bond’s specific characteristics. However, many investors fail to monitor bonds once they become part of their portfolio, despite potential changes in risk over time. These changes can have a significant impact on their overall portfolio risk.
Some of these evolving risk factors include:
- Changes in the issuer’s financial condition, which impact their ability to make timely interest and principal payments.
- Changes in prevailing interest rates that impact the value of the bond in the secondary market.
- Changes in the credit rating that impact a bond’s valuation.
- Changes in the bond’s liquidity due to various reasons, which impact an investor’s ability to sell the bond and/or the ease of assessing the bond’s value at any given point in time.
If a bond defaults, investors should review the bond’s indenture in its official statement, which contains bondholder rights and remedies, as well as monitor the bond for continuing disclosures that pertain to its repayment plans. It’s often best to work with a qualified financial advisor in these cases to ensure that your rights are enforced.
There are several ways to keep up-to-date with these changing risk factors. For example, MunicipalBonds.com provides an easy way to access official statements and issuer details, as well as view trades in the secondary market. Many other financial publications cover broader economic issues that could influence interest rate decisions.
Use our Screener to find the right municipal bonds for your portfolio.
What Metrics to Monitor
The two biggest risk factors for investors to monitor are the issuer’s financial conditions and the bond’s liquidity.
The issuer’s financial condition can be monitored in two ways:
- Issuer-provided disclosures
- Third-party credit ratings
While credit ratings are easier to understand, they aren’t available for every bond issue and they may not be updated on a frequent enough basis to cover every risk factor. This means that it’s important for investors to follow disclosures too.
The three most important things to monitor on a continual basis include:
- Official Statement – The official statement provides investors with information about the issuer’s financial condition and risk factors, as well as a description of the terms and features of the bond. It’s a must-read before buying a bond and an important ongoing reference. If you want to learn more about official statements, click here.
- Continuing Disclosures – Continuing disclosures provide important updates on the issuer’s financial condition, as well as specific material events that arise after the bond issuance which can impact key bond features. It’s a must-read for investors to keep track of ongoing risks. Read more on continuing disclosures here.
- Credit Ratings – Credit ratings represent an analyst’s opinion regarding the probability of timely repayment of principal and interest, as well as the likelihood of default. Credit ratings can change at any time and may not reflect the current condition of the issuer and/or bond.
A bond’s liquidity can be measured by looking at the secondary market trading activity. In addition to assessing a bond’s value, this trading activity provides an idea of how easy it would be for an investor to sell a bond before it matures. Even investors that don’t plan on selling should assess liquidity risks in case they ever need to sell.
Price discovery tools can help value bonds that don’t trade very frequently by finding and comparing the prices of other bonds with similar characteristics.
The Bottom Line
The municipal bond market may not be as fast-moving as equities or futures, but that doesn’t mean that investors should ignore their bond holdings. It’s important to keep up-to-date with any changes to an issuer’s financial condition or any bond characteristics that could impact investment risk.
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