What if munis are headed for a meltdown?
One of the principal tenets of disciplined investing is, what if you’re wrong. It’s all well and good to have a view of the world that allows you to avoid panicking and stuffing your cash in a mattress—or in T-Bills—but what if your investment outlook is mistaken?
With equities, we call it the margin of safety. How much is a business worth when broken up. If the economy tanks, what’s the minimum free cash-flow that the company would generate? Measure its present value, and you get the business’s intrinsic value. If you can buy a stock at or below its intrinsic value, you’re protected if things go wrong.
With bonds, we protect ourselves by focusing on well-managed issuers providing essential services. For example, many municipalities borrow against their water system or electrical system, and use the fees that system charges to pay the interest. The bondholder has a first lien on the revenue. Even if the city goes broke, the bondholders get paid.
Essential services bonds provide a significant level of security. There are services like water, electricity, and education that all communities need. There are other services like sports stadiums and monorails that are optional. Bonds from growing regions of the country—like Texas—or from low-tax states like Florida or New Hampshire are also safer than bonds from low-growth high-tax regions like Ohio or Wisconsin
We look after our equity investments by focusing on price. We look after our bonds by analyzing quality. In either case, we’re protected if things go wrong. Because eventually, they will.
Douglas R. Tengdin, CFA
Chief Investment Officer
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