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Capital Markets

Muni bond arbitrage: Getting high yields out of triple A paper

As an increasing number of hedge fund managers chase similar strategies in a bid to make returns, Bryan Williams asks why more aren’t looking at municipal bond arbitrage.

Bryan Williams, Rockwater Hedge “Muni bonds have to offer a yield premium at the long end to incentivize investors. An individual has to consider whether they will be in the same tax band in 20 years’ time”
Bryan Williams

Williams is the managing principal of Rockwater Hedge, a fund of hedge funds investing only in managers applying that strategy.

It is not an easy job. As far as he knows, there are only about 25 municipal bond arbitrage hedge funds in the US. Yet given that there are approximately 60,000 issuers of muni bonds, and 2 million of such bonds in issuance, there is ample room for more players.

Williams says demand for municipal bonds is growing. Their appeal began in the 1980s when wealthy individuals began looking for tax-exempt funds instead of mutual funds. Municipal bonds are tax efficient. US high-net-worth investors would have to earn at least 35% more in a taxable investment to get the same returns they can achieve from municipal bonds.

The appeal of municipal bonds for arbitrage lies not only in their tax benefits but also in the pricing phenomenon that exists across the maturity spectrum.

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