Adapted from Private Debt Investor
There are plenty of overly risky areas in today’s markets—where the risk/reward ratio is very unfavorable—now that we are 10-plus years into a period of extreme government liquidity creation, says Dan Zwirn, CEO and CIO of Arena Investors.
One area where the risk is higher than many investors may appreciate is US municipal revenue bonds. Many of these issues, Zwirn notes, are for seemingly private businesses (such as luxury home developments or “elite” student housing) rather than for the public good and never should have been municipal securities in the first place, while and their municipal backing and tax-advantaged treatment creates an impression that they are immune from serious consequences—a false impression.
Zwirn says that a day of reckoning for many muni revenue issues is extremely plausible, especially because the presumed sources of revenue to pay coupons—such as the students expected to pay rent for elite student housing—may not materialize due to Covid-related changes in behavior. Potential state and local government insolvency is another possible catalyst for default.
As in many irrational markets, there are some good opportunities for investors who can comb through scores of issuers. With continuing intervention by monetary authorities and governments, even insolvent entities may have ready access to liquidity, forestalling distress across the sector. And there is so much irrationality to be unwound that opportunities, though not easy to identify, may persist for decades.