Municipal Market Performance and Benchmark Rates: Rising rates, treasury volatilty, and elevated supply proved too much to handle for muncipal performance in July as both indices lost ground this month. The investment grade municipal bond index (LMBITR) lost (0.28%), extending year-to-date losses to (0.63%). The Bloomberg Barclays Municipal High Yield Index underformed, losing (1.05%) in July, increasing year-to-date losses to (1.92%).
Chaotic tariff policy uncertainty, and the potential effects on inflation, drove rates in the US Treasury market higher as 5 to 30 year maturities were anywhere from 11 to 16 bps higher, depending on tenor. The AAA Municipal Benchmark curved meaningfully steepened in July as 5-year rates fell by 19bps, while 10 and 30-year rates rose by 6 and 17bps, respectively. Clearly, high grade muncipal investors remain cautious amidst broader rate volatility and are targeting short (inside 5 year) duration to “wait out the storm”.
Mutual Fund Flows: Despite a mid-month hiccup, municipal fund flows remained positive in July. Both IG and HY fund complexes saw inflows in 3 out of the 4 weeks and have now experienced inflows in 13 out of the last 14 weeks dating back to April. Investment grade inflows totaled $2.3B this month while total HY fund flows were marginally positive at $.3B. Year-to-date fund inflows still favor HY ($4.7B), which have garnered just over 50% of total inflows despite representing only a fraction (15%) of the overall municipal market.
Primary Market Supply: A central and persistent theme this year has been the record breaking issuance, July was no exception. Historically, July is a lighter month for municipal new issuance, but 2025 defied historical expectations, as issuance will eclipse $50B, an increase of 35% year-over-year. While year-to-date supply is only ~15% higher versus 2024, issuance in the first half of the year (through June 30) was 55% higher versus the trailing 5-year average. While high-yield new issue totals remain subdued versus the trailing 5 and 10-year averages, especially when compared to the significant YoY increase in investment grade issuance this year, the pipeline of attractive non-rated issues endures.
As active participants in the non-rated municipal bond market, we have been asked our view on what happened to the Easterly ROC Muni High Income Municipal Bond Fund (the “Fund”) and does it represent an endemic risk to the market?
Looking Back: In October 2024, the Fund AUM was $341 million with a NAV of $7.34 (total shares – 46.5 million). Throughout Q4-2024, it appears the Fund experienced a steady stream of investor redemptions, with total shares declining nearly 25% over the quarter. The NAV fell 5.3% over the quarter (compared to -1.4% return for the Bloomberg High Yield Municipal Index [LMHYTR]). We infer the redemption process was largely orderly, and the portfolio manager was able to obtain prices for the security sales at or close to their stated “market value”. Open-end mutual funds provide investor redemptions next day settlement, so it is likely the portfolio manager sold their most liquid assets to meet the investor redemptions. This would inevitably leave a less liquid residual portfolio unless there was a repositioning of illiquid positions with new fund assets or swapping existing holdings for new ones.
Q1-2025 was relatively quiet for the fund, with outflows slowing to 1.6% for the quarter and NAV falling 4.7%. However, the outflows accelerated in Q2-2025, with outstanding shares falling to 27 million by mid-June. On June 13th, there were either market trades or portfolio price mark-downs (or both) that resulted in NAV falling 35% overnight. Not surprisingly, this led to a rapid acceleration of investor redemptions and decline in NAV (see Table). Given the daily liquidity provided to investors, the portfolio management team had to be sure they would have assets necessary to meet redemptions and that portfolio pricing was reflective of what could actually be raised to meet investor redemptions. Marking down the portfolio by 35% on the 13th and 21% the following day (49% total) likely ensured the fund had sufficient funds to meet the onslaught of redemptions were sure to, and did, follow.
Why Did this Happen? We can only make educated guesses, rooted in our market experience, as to why these issues led to the collapse of the Easterly fund. We have always believed that the open-end fund structure is not suited for the relative illiquidity of the high yield municipal market. Providing investors next day settlement for assets that trade infrequently can be a significant challenge. When a higher concentration of illiquid and speculative assets are added to the mix, the mis-match issue can become a recipe for disaster. This is likely what happened to the Easterly fund.
Based off the Fund’s holdings as of May 31, 2025 submitted to the SEC and Bloomberg data, 48% of the portfolio was considered “distressed.” Likely, after selling down the most liquid and higher quality credits in the portfolio to meet earlier redemptions, the Fund was left with a disproportionate share of troubled deals. Digging deeper, many of these deals were backed by highly speculative borrowers, such as energy transition and economic development projects. The high concentration of these deals was likely reflective of a chase for higher yields. Given their speculative nature and relative illiquidity, these issues are often offered with a significant yield premium to compensate investors for the higher degree of risk. A high concentration in these assets quickly became an issue when fund redemptions accelerated. Facing these redemptions, it likely became apparent that many of the Fund’s securities were overvalued (perhaps validated by a trade by an unrelated party at a deeply discounted price) and the portfolio management team had to take action to ensure liquidity. It has been widely reported and obvious given current AUM that the portfolio management team sold most, if not all, of their distressed holdings at “fire sale” prices, given the dramatic decline in NAV and AUM. In addition to the high concentration of distressed assets, the Fund also had exposure to private placement deals, which are extremely illiquid, and likely had to dispose of these assets at significantly discounted values when under pressure from investor redemptions.
In our opinion, a few main pitfalls and an unfortunate confluence of events combined to cause the Fund’s liquidation. First, the inherent mismatch of the open-end mutual fund structure’s liquidity (daily) with the underlying assets. We have long held this belief and have structured our strategy to align with the relative illiquidity of the asset class by offering separately managed accounts and an interval fund vehicle. When faced with cascading investor redemptions that must be met daily, it is nearly impossible for open-end fund managers to exit positions at their fair value. Second, proper credit selection trumps incremental yield. While offering yields on speculative deals can be enticing, the exposure to elevated credit risks can be disastrous for long-term investors…again, especially when the portfolio management team is forced to liquidate positions. We have found that long-term investors are better served by focusing on performing credits that undergo rigorous due diligence & surveillance to preserve credit quality of the portfolio. Lastly, exposure to private placement deals in our market must be handled appropriately. Additional liquidity risks must be addressed by the investment vehicle, and an appropriate yield premium is warranted. We choose not to participate in private placements and prefer maintain liquidity. We size our credit exposure to act nimbly when needed.
In addition, our strategy and long-term approach allow us to be opportunistic during events of dislocation such as this. When Easterly began liquidating their public holdings in late Q4-2024 and early 2025, we were eager buyers of our “approved credits” at deeply discounted prices. While the discounts negatively impacted price performance in the near-term, we were able to acquire assets at very attractive yields, which we believe will be accretive to our long-term investors.
Our biggest takeaways from the Easterly debacle support our core investment philosophies: We believe that investment structure needs the match the strategy and asset class (a mismatch can have catastrophic consequences), fundamental credit analysis is the foundation of every decision, and opportunistic capital deployment during periods of dislocation can significantly benefit long-term investors.
The chart above shows the increase in value of $1,000,000 invested in the LCP composite at inception (net of management fees and expenses) vs. the benchmark, the Bloomberg High Yield Muni (LMHYTR) as well as the Bloomberg Muni (LMBITR) indices (it is not possible to invest in either Bloomberg Index). Please contact us with questions regarding credit profile, returns, taxable equivalent yields or further portfolio information. Past performance is not indicative of future results.
Sources: Refinitiv and Bloomberg LP