How exposed are U.S. Municipal Bond funds to a Puerto Rican default?
In light of the Governor of Puerto Rico announcing the possibility of further defaults, MPI wanted to understand the possible effects on U.S. mutual funds that invest in Puerto Rican municipal bonds. We ran quantitative analysis on all of Morningstar’s municipal bond categories, analyzing the return streams of 562 funds identifying potential exposures ranging as […]
In light of the Governor of Puerto Rico announcing the possibility of further defaults, MPI wanted to understand the possible effects on U.S. mutual funds that invest in Puerto Rican municipal bonds. We ran quantitative analysis on all of Morningstar’s municipal bond categories, analyzing the return streams of 562 funds identifying potential exposures ranging as high as 50%1 in 29 funds from a small cluster of fund families, including Goldman Sachs, Franklin and Oppenheimer, whose Puerto Rican bond exposures were the subject of a December 2015 Bloomberg article.
In the chart, bubble size depicts fund AUM, while showing each fund’s exposure to Puerto Rican debt tracked against the strength of our analysis (as measured by Predicted R-Squared, MPI’s proprietary measure of predictability). Notice that some of the larger funds also appear to carry strong exposure; for example, the $5.6 Billion fund in the center of the chart holds an approximately 31% exposure to the Puerto Rican Index, with our quantitative model indicating an 80% Predicted R-Squared.
Because our quantitative analysis does not rely on fund holdings information, it can help investors fulfill their obligations to understand their funds’ investments, and the risks accompanying higher yields, even when little to no position data is available, or when the fund’s positions and investing changes are difficult to decipher due to the use of derivatives or other complex investment products. In this case, while the clustered exposure indicated that there appeared to be a lack of systematic U.S. mutual fund exposure to the Puerto Rican bond market, the insight of deep exposure in concentrated fund families can help investors better identify their true diversification and exposure profiles
Footnotes
- 1Source of fund return data: Morningstar. Funds were analyzed using MPI’s patented Dynamic Style Analysis (DSA) technology. Analyzing a period of two years of daily returns, we compared funds to two indices representing investment-grade municipal bonds, one index representing high-yield bonds, and one index representing the Puerto Rican Bond index. Please see the chart for specific exposure ranges.