HOW DOES THIS STRATEGY PRODUCE ADDITIONAL RETURN COMPARED TO A BUY-AND-HOLD STRATEGY?
There are two elements that make up a bond portfolio’s total return — namely, yield and capital gains/losses. For a buy-and-hold strategy, a portfolio’s total return over an investment cycle will be roughly equal to its average yield over the period. This is because any unrealized capital gains/losses are extinguished when a bond matures or is called away. Through its design to actively sell holdings prior to their maturity or call date, our Extended Value strategy has the potential to realize capital gains rather than letting them diminish over time, thereby increasing the total return in our portfolios. Moreover, this additional return can come from three sources, including (1) changes in interest rates, (2) changes in a bond’s spread, and (3) rolldown return. The Extended Value strategy seeks to bolster a portfolio’s total return by using our extensive quantitative and market research to invest in callable municipal bonds that optimize sources (2) and (3).
 Return is equivalent to yield in the case that all coupon payments are reinvested at the same yield, which is typically not the case.
 Assuming the bond was not purchased at a discount. This is likely not a concern for this strategy since it was designed to operate in the premium space.
SHOULD AN INVESTOR BE CONCERNED WITH INCURRING CAPITAL GAINS IN THIS STRATEGY?
While an investor in the Extended Value strategy can expect to realize capital gains as part of the active management of their portfolio, we are conscious of sensitivity to tax consequences. To that end, we take into account whether the additional return generated by the strategy outweighs the tax impact of capital gains. In addition, we endeavor to further optimize tax efficiency by actively harvesting capital losses during periods of larger interest rate increases — simultaneously taking advantage of a favorable reinvestment environment as we look to swap into higher-yielding securities.
WHY IS THIS STRATEGY COMPRISED ENTIRELY OF CALLABLE MUNICIPAL BONDS?
Municipal bonds are generally issued with call features that may be exercised after 10+ years. Given that portfolios managed under this strategy are laddered from 10 – 20 years, callable municipal bonds comprise the universe of bonds available for selection.
This is by design, as we believe that callable bonds are a source of opportunity. Because the Thomson Reuters Municipal Market Data (MMD) AAA curve (i.e., the industry standard for pricing municipal bonds) makes structural assumptions that don’t account for the market’s variety of coupons and embedded call options, callable bonds can be mispriced if valued solely off of the MMD curve. In using a proprietary interest rate and pricing model in our management of this strategy, we seek to more accurately evaluate bond prices to add value in a municipal bond portfolio.
See our callable municipal bonds white paper and webinar for an in-depth explanation of the callable municipal bonds, including key terms and how we find value through quantitative analysis.
IS EXTENDED VALUE CONSIDERED AN INTERMEDIATE- OR LONG-TERM STRATEGY?
With a maturity range of 10 – 20 years and an expected duration in the seven- to eight-year range, this strategy resides on the longer end of our intermediate strategies.
HOW DOES THIS STRATEGY COMPARE TO INTERMEDIATE VALUE?
While both of these strategies reside in the intermediate space and seek to be fully invested at all times, they differ in their allowable maturity-call combinations, level of duration, and management style. To compare, Intermediate Value is partially comprised of non-callable bullet bonds and captures a shorter but wider set of callable municipal bonds, spanning 1 – 15 years to maturity. Extended Value, on the other hand, is comprised entirely of high-coupon callable bonds and spans fewer, albeit more targeted, callable structures, spanning 10 – 20 years to maturity. Since Extended Value is concentrated in longer maturities and calls than Intermediate Value, it maintains a longer duration, pushing it farther out in the intermediate space. Also, while Intermediate Value seeks to provide extra yield above that of a standard intermediate-term ladder through a mainly buy-and-hold strategy, Extended Value aims to enhance total return through active selling that targets favorable levels of additional return mainly attributable to how particular callable bond structures roll down over time.
 Bonds are sold in the Intermediate Value strategy only when they are short enough to be considered cash equivalents.
HOW DOES THIS STRATEGY COMPARE TO OPPORTUNISTIC VALUE?
Both of these strategies strategically invest in callable municipal bonds, but they differ in their permissible maturity and call ranges, duration flexibility, and management style. While Opportunistic Value’s flexible duration and wide range of allowable maturity-call combinations position it to capitalize on misunderstood credits and market dislocations across the entire municipal yield curve, Extended Value’s more targeted structure and active selling component position it to focus on enhancing returns by capturing attractive levels of price appreciation via rolldown and, at times, spread tightening. In turn, unlike Opportunistic Value, which has a variable duration based on buying conditions, Extended Value maintains a more steady duration and remains fully invested at all times.
HOW WOULD THIS STRATEGY BE MANAGED WERE THE MUNICIPAL YIELD CURVE TO INVERT?
Should a full municipal yield curve inversion occur, we would expect to hold positions until we determine it makes sense to sell, taking into account: reinvestment yields, reinvestment rolldown potential, duration maintenance, and the monetary policy environment. However, we believe that it is important to note that although the Treasury yield curve has historically experienced short-lived inversions, to date, the municipal yield curve has never exhibited an inversion.
HOW IS THIS STRATEGY STRUCTURED TO PERFORM WHEN THE MMD MUNICIPAL YIELD CURVE IS FLAT?
The Extended Value strategy is designed to outperform the yield of a comparable buy-and-hold strategy whether the MMD curve is flat or steep. That being said, looking only at the yield differential between maturities along the curve tends to significantly underestimate how steeply some callable bonds roll down over time, especially those with longer maturities and wider gaps between years to maturity and years to call. In market environments where the MMD curve is flatter and the amount of additional yield gained per extra unit of duration may look less attractive, there are two further considerations. First, flat yield curves tend to indicate later stages of an economic cycle and thus limited potential for additional rate increases, making any additional yield achieved in this extended duration strategy even more attractive. Second, this strategy is still able to capture positive rolldown return even when the MMD curve is flat, as explained in our white paper and webinar on callable municipal bonds.
CAN EXTENDED VALUE PORTFOLIOS BE CUSTOMIZED BY STATE?
Investors residing in California and New York can optimize tax efficiency by choosing a California or New York state-specific Extended Value portfolio, respectively. In consideration of clients’ best interests, we only purchase bonds with high-quality credit profiles that adhere to our strategy objectives. For this reason, other state-specific options are not available given that we do not see sufficient availability of attractive bonds that fit our investment criteria for this strategy while supporting portfolio diversification.
To learn more about how we can customize portfolios to meet investors' specific investment objectives, please contact our Advisory Services team by calling (858) 436-2200 or by emailing