When Detroit defaulted on $19 billion in general obligation bonds, it barely caused a ripple in the $3.7 trillion muni market. But for the unlucky few who held those bonds, it’s a dime-on-the-dollar catastrophe. What’s the lesson we can learn from the Detroit experience?
Bond defaults are very rare these days. The wave of big muni defaults that Meredith Whitney famously and emphatically predicted in 2011 – which she promised would total hundreds of billions of dollars – never materialized. Most cities and agencies are able make interest payments on schedule.
But that does little to appease Detroit bondholders who will lose big. The Detroit calamity is a good reminder that a bond is a loan, in this case a loan to the mayor and city council of a city with a shrinking population and endless economic problems. Some such loans are tied to specific and generally reliable revenue streams, such as tolls collected on an expressway, or revenues from casinos. Detroit’s general obligation bonds, however, were backed only by a promise from the city to repay them, a promise the city is not able to keep.
Spread the risk
Rare situations like this reinforce our ETF investment strategy. The municipal bond asset class is an important ingredient in many of our client portfolios, but instead of holding individual bonds, we utilize municipal bond ETFs. These ETFs are essentially pools of hundreds of bonds offered by municipalities across the country. The value of the ETF moves based on interest rates and the ability of those bond issuers to make payments. With so many issues in the pool, a single default like Detroit’s has minimal impact on the ETF as a whole.
Yes, this is just plain old diversification. We see spreading the risk as essential not just for stocks, but for bonds as well. ETFs make it easy.
For our most popular posts, click here.
This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.
Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.
Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.
All municipal bonds and muni bond ETFs involve risk and may fall in value.
delivered to your inbox
This communication may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.”
“Historical performance is not indicative of future results. The investment return will fluctuate with market conditions.
Past performance is not indicative of any specific investment or future results. Views regarding the economy, securities markets or other specialized areas, like all predictors of future events, cannot be guaranteed to be accurate and may result in economic loss to the investor.
Investment strategies, philosophies, allocations and holdings are subject to change without prior notice.
This communication is intended to provide general information only and should not be construed as an offer of specifically tailored individualized advice.
While the Adviser believes the outside data sources cited to be credible, it has not independently verified the correctness of any of their inputs or calculations and, therefore, does not warranty the accuracy of any third-party sources or information.
Adviser does not endorse the statements, services or performance of any third-party vendor.
Unless stated otherwise, any mention of specific securities or investments is for hypothetical and illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable.
Any IPO alerts are purely informational and should not be construed as recommendations to invest.
Adviser is not licensed to provide and does not provide legal, tax or accounting advice to clients. Advice of qualified counsel or accountant should be sought to address any specific situation requiring assistance from such licensed individuals.
Any case studies or hypothetical client profiles are for demonstration purposes only. They illustrate the breadth and depth of the many clients we represent at various life stages. Any similarities to actual Adviser’s clients past or present are strictly coincidental. Individual advice and results will vary based on each client’s circumstances, objectives and prevailing economic conditions.