Market participants see opportunities in diversification, SMAs

The year 2025 brought a lot of uncertainty — macro, geopolitical, muni-specific policy and unknown headlines risks — and volatility is expected to continue, market participants said during a panel, “How is the Investor Landscape Shifting,” at the Bond Buyer’s 2025 National Outlook conference on Thursday.

Concerns include changes in tax policy, market volatility, increasing overall costs, loss of federal funding for infrastructure, and climate change/severe weather. The conference’s Live Market Survey found nearly three-fourths of respondents believe changes in tax policy — including the potential, but unlikely, elimination of the tax exemption — will have the biggest impact on the muni market.

“Our job is to take that volatility, figure out what’s noise, figure out what’s reality, and lean into the opportunities as we see them,” said Alex Petrone, director of fixed income at Rockefeller Asset Management.

Portfolios “should be managed on a day-to-day basis with that baseline view inside, but also making sure you also can protect where you can” due to tail risks, said Ed Paulinski, a managing director at Goldman Sachs.

Risk, though, should not be taken “off the table” necessarily, said James Pruskowski, chief investment officer at 16Rock Asset Management, as his baseline view is things “should be relatively OK.”

“Whether it’s adding liquidity in the front end of the portfolio, maybe adding Treasury exposure, where you can offer something to offset muni-specific volatility, preparing for both muni-specific or macro volatility will benefit portfolios,” he said.

The “game plan” has always been to diversify one’s portfolio, “carry some dry powder here and ensure front-end liquidity, whether T-bills or short munis. Petrone said.

“For us, it’s always about within a given risk budget, how are we best optimizing relative value today, leaning into sectors that are cheap, leaning into areas of the curve where you anticipate that you can benefit from roll down and carry,” she said.

This year’s more prominent issue is climate risk and natural disasters, especially in the wake of the devastating California wildfires.

“You can’t hide behind some mistakes, so you have to be at the forefront of holding investor calls and delivering transparency and engagement one-on-one,” Pruskowski said.

Managing P&C liabilities has always been “a part of managing munis portfolios, not double downing on where you’re insuring the exposure. So it may be new to retail, but being cognizant of climate risk, flood risk, all these types of things, has always been part of the equation,” he said.

Within the market, separately managed accounts portfolios have taken a sizable share of the overall buyside opportunity. At the same time, there has been a drop off from banks and insurance companies, said Chris Brigati, chief investment officer at SWBC, who moderated the panel.

This year, investors will continue to see the continued growth of separately managed accounts.

The latest Fed data shows household ownership of munis — which includes direct ownership of individual bonds in brokerage accounts, fee-based advisory accounts and separately managed accounts — surged to $1.86 trillion in Q3 2024, up 3.4% from Q2 2024 and 15.1% in Q3 2023.

Some peg SMAs at 25% to 30% of the market, said Paulinski, who noted SMAs are entering their “third stage” of growth.

The first “spike” occurred after 2008. From there it moved from the brokerage model into financial advisors, as market participants did not want to do it themselves anymore, he said.

“You also see a client want more customization, more transparency and at lower fees,” Paulinski said. “And that’s where you see a huge uptick in the growth of assets for the past couple of years.”

There has also been a rise in interval funds over the past several years, Petrone said. Rockefeller, which launched its interval fund on Dec. 9, was among a trio of firms that created such funds over the past several months.

“Banks and insurance companies, now that they are less active in our market when we have an outflow cycle, we always think of who’s the next marginal buyer,” Petrone said.

“And in the separate account space, we don’t have cash, it’s not going to be you,” she said. “But as we see the rise of the interval fund structure, with more of them coming to the market, that becomes your next marginal buyer through an outflow cycle because you have certainty on terms of liquidity, and you don’t have to worry as a portfolio manager around when is retail going to ask for liquidity.”

Overall, investors are demanding more, Petrone noted.

“They have gotten more accustomed to separate accounts that do more passively managed and now they want the active investment, whether that’s munis exclusively or looking across the entirety of the fixed-income situation,” she said. “So this will just keep pushing forward in terms of activity.”