Where a Top Muni Bond Fund Manager Is Finding Opportunity Now

The fund saw inflows during 2022’s bond rout when other muni bond funds saw outflows. That allowed Fitterer to add some higher-yielding bonds with slightly lower-quality credits, which has helped Strategic Muni outperform this year.

The fund has beaten 97% of its national intermediate muni peers with a 0.07% return over the past three years, versus a 1.3% average loss for other national intermediate muni bond funds, according to Morningstar. It has also outpaced the Bloomberg 1-10 year Municipal Blend Index over that period, net of its 0.55% fee for its investor shares.

Strategic Muni launched in 2019, but Fitterer spent 30 years at Wells Fargo Asset Management—since renamed Allspring—before coming to Baird, including co-managing the
Allspring Strategic Municipal Bond
fund (STRIX) from 2010 to 2019, which outperformed its peers during his tenure.

He is applying the same investment philosophy he used at Allspring to Strategic Muni, departing from the benchmark’s duration and credit quality to take advantage of market dislocations. (Duration measures interest-rate risk tied to a bond’s or bond fund’s maturity, yield, and other factors.) The fund imposes guardrails to prevent it from taking the moonshots that can get an unconstrained bond fund in trouble, he says.

Fitterer uses a tactical approach to risk-taking and hunts for opportunities in both the taxable and nontaxable bond markets. (Taxable holdings are limited to 20% of the fund.) The muni market is driven by retail investors, making it inefficient, he says, resulting in opportunities to buy undervalued and unloved securities without taking on too much risk.

He and his seven-person muni bond team, including co-lead manager Duane McAllister, analyze various factors, including yield-curve exposure, duration target, credit perspective, and the sector and quality of a security relative to the index. The team, which is part of Baird Advisors’ larger fixed-income group, also receives support from corporate-credit and structured-product analysts.

Strategic Muni can vary the benchmark’s duration by two years. The fund’s current duration is 4.5 years, versus the benchmark’s 3.5 years. That duration target reflects Baird’s viewpoint that the Federal Reserve is closer to the end of its interest-rate hiking cycle. The central bank may have another rate hike or two left, Fitterer says, but he believes it will keep the federal-funds rate above 5% for now.

“You need to take the Fed at their word,” he says.

Fitterer has used derivatives to extend the fund’s duration, buying five-year Treasury note futures, which comprise 2.5% of assets. (The fund limits its derivatives holdings to 10% of assets.) The Treasury futures efficiently changed the fund’s yield-curve position, says Fitterer, who bought the contracts when five-year Treasury yields were more attractive than muni yields.

The fund can hold up to 30% in high-yield bonds, although Fitterer has never held more than 15% as a manager. Currently, high-yield is just under 9%, split between 3% in bonds rated below BBB and 5.2% in non-investment-grade nonrated bonds. He finds good short-term opportunities in nonrated bonds and relies on internal Baird ratings for guidance, such as the BBB+ rating on IDEA muni bonds, a large, multistate charter-school operator based in Texas.

In July 2022, Strategic Muni bought IDEA bonds yielding 5.25% from the Florida State Development Corp. due in June 2029 and callable in June 2027. The school operator has opened four Florida charter schools since 2021, with 16 planned by 2026. IDEA seeks to be an alternative to low-performing schools; recently it received $9.3 million in Florida state funds. Fitterer sees promise in IDEA’s expansion, pointing to success in Texas and noting that Florida is generally welcoming to charter schools.

Fitterer likes to fish for deals in unloved areas, and education and healthcare are among the sectors with the heaviest weightings in the fund. In October 2022, he first bought bonds issued by multistate hospital system Commonspirit Health, a 5% bond due in August 2049 and callable in August 2029. Post-Covid, hospitals overall have been beset by higher labor costs and struggling operations, but he says the hospital has great management and built out its own traveling nurse agency, allowing it to better manage labor costs during the pandemic.

Looking ahead, the team is focused on the impact of a potential recession on state and local governments, even as many states’ rainy-day funds are sitting at record levels. A recession may hit states with big pension deficits like Illinois and New Jersey the hardest, and Illinois is the fund’s largest state exposure. “There have always been credits within the state of Illinois—great credits that get tainted by what’s going on in the state,” Fitterer says.

There’s a difference between owning short-term, local, higher-quality credits and state-issued long-term debt, he argues. He points to the A-rated Peoria School District noncallable bonds that the fund bought in February, yielding 4.08% and due in December 2025, as an example of digging into a sector and taking a broader perspective.

“It’s finding good credits in what would be characterized as a poor sector,” he says.

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