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A New Paradigm - Wednesday, 06/13/2012

With investor sentiment now shaded by the daily changes in market direction for both equities and fixed income, I suggest that we are faced with a changed investment paradigm, at least in the near term. While Europe tries to extricate itself from economic doom and gloom, many major equity indices struggle to post positive year-to-date returns1. In my opinion, as shown in the table below, inflows into fixed income may be an indication that it is currently the preferred asset class over equities. More specifically, I believe municipal bonds have generally offered investors some sense of stability. The Barclays Municipal Bond Index2 returned 3.43% year-to-date, with an average coupon of 4.90%3. This generated enough return to help investors weather momentary downturns in market value.

Managing investor expectations means a modification to the risk/return equation. If risk, in the form of price volatility, continues to take a hit on total return, then perhaps investors will consider fixed income as the predominate return generator in their asset allocation, since coupons generally are a steady source and component of total return.

If you couple the average coupon of the Barclays Municipal Bond Index with the current spread of 216 bps3 between the Barclays BAA Municipal Bond Index with the Barclays AAA Municipal Bond Index, an investor may have reason to believe that any economic improvement would result in the narrowing of this spread to its long-term mean of 121 bps3. This would potentially generate 95 bps of excess return. However, without any improvement, the coupon alone generated nearly 5.00% to returns year-to-date. With today's uncertain markets, I think investors might find this appealing.
 

 Broad Asset Class Flows YTD ($Mil) 

Asset Class 

Estimated Net Flow 

Fixed Income 

118,844

Equity 

(1,633)

Balanced 

17,415

Other

6,462

Source: Morningstar, May 31, 2012. Note: Balanced funds invest both in equity shares and fixed-income-bearing instruments (debt) in some proportion.

1All year-to-date references are as of June 8, 2012.
2The Barclays Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least one year. The Barclays Municipal AAA, BAA Indices are subsets of the broader index.
3Source: Barclays Municipal Credit Research, May 2012.
 

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Please note that the information herein represents the opinion of Jim Colby and these opinions may change at any time and from time to time. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Current market conditions may not continue. Non-Van Eck Global proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of Van Eck Global. © 2014 Van Eck Securities Corporation. MUNI NATION is a trademark of Van Eck Associates Corporation.

All indices listed are unmanaged indices and do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in the Fund. An index’s performance is not illustrative of the Fund’s performance. Indices are not securities in which investments can be made.

Any discussion of specific securities mentioned in the commentary is neither an offer to sell nor a solicitation to buy these securities.

Municipal bonds are subject to risks related to litigation, legislation, political change, conditions in underlying sectors or in local business communities and economies, bankruptcy or other changes in the issuer’s financial condition, and/or the discontinuance of taxes supporting the project or assets or the inability to collect revenues for the project or from the assets. Bonds and bond funds will decrease in value as interest rates rise. Additional risks include credit, interest rate, call, reinvestment, tax, market and lease obligation risk. High-yield municipal bonds are subject to greater risk of loss of income and principal than higher-rated securities, and are likely to be more sensitive to adverse economic changes or individual municipal developments than those of higher-rated securities. Municipal bonds may be less liquid than taxable bonds.

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