US fixed-income markets managed to eke out modest gains during the second quarter, thanks in part to the steady stream of coupon income. Despite rising US Treasury yields and widening credit spreads, investors were heartened by signs of slowing disinflation, which led to reduced expectations of Federal Reserve rate cuts. Securitized sectors generally outperformed credit, with the Bloomberg Municipal Bond 1-15 Year Blend (1-17) Index returning -0.34% during the quarter.
The Hartford Sustainable Municipal Bond Fund (HMKIX, I Share) stood out, outperforming the Bloomberg Municipal Bond Index over the period. The fund’s success was driven by savvy security selection in high-yield and investment-grade revenue bonds, particularly in the healthcare sector. An overweight allocation to IG revenue bonds also contributed to the fund’s outperformance, with notable contributions from healthcare, education, transportation, and housing.
The top ten holdings in the fund included a mix of revenue bonds and general obligation bonds, with the California Municipal Finance Auth, CA, Rev taking the top spot at 2.54%. Other notable holdings included the State of Illinois, IL, GO and the Central Texas Regional Mobility Auth, TX, Rev.
Despite the challenges posed by rising yields and credit spreads, fundamentals in the municipal bond market remain broadly positive, thanks to generous federal support and the ongoing recovery from the pandemic. Many municipal sectors have natural outlets for inflationary pressures, although labor-constrained sectors may face greater challenges.
Looking ahead, municipal bonds are likely to behave defensively in a downturn, thanks to their high quality and strong balance sheets. While tax-exempt municipal valuations may appear unattractive relative to history, municipal bond all-in yields look attractive compared to comparable quality corporates at intermediate and long maturities. With demand expected to remain robust, particularly if rates begin to trend lower, the outlook for municipal bonds remains promising.
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