Municipal Strategy: The Active Edge

Research evidence excerpt

Municipal Strategy: The Active Edge

IdeaMtotal returns: The correlation between distribution yields and total returns

is positive but low ( Exhibit 10 ).

• Evaluate manager skill for SMAs & mutual funds (or IG vs. HY)

separately: Within product families, mutual fund alpha does not appear

correlated to SMA performance. Given that SMAs are tech-driven, that

would make sense. Similarly, we found that portfolio tactics that were

associated with better performance for IG funds did not hold for HY funds.

HY fund performance had idiosyncratic drivers, with lower evidence of

returns persistence.

• Before picking a short-duration strategy, think about the cost of waiting:

The steep tax-exempt curve means that short-duration active strategies have

less potential for outperformance. There is a real cost to waiting for higher

rates.

• Ask the manager to quantify tax alpha: Leading SMA managers can

quantify tax alpha. In an ideal world, tax alpha should offset the manager fee.

Ask about the manager's approach – both in identifying loss candidates as

well as ensuring prompt reinvestment.

• Look for a tax-optimized transition analysis: Higher active share usually

outperforms, but it shouldn't come with a high capital gains bill. Seek

proposals where a manager would transition strategies tax-efficiently.

Modestly lower composite returns can still be optimal if it reflects lower

turnover of inherited positions.

• Consider fee and tax implications before replacing a completion sleeve

fund with a separate ETF: The demand for ETFs has led many investors to

ask about pairing SMAs with active ETFs, as opposed to relying on the bolt-

on completion fund offered as part of many longer-duration SMA strategies.

Consider that some states have a 50% threshold for a pro-rata interest

exemption.