Entrepreneurs Need to Rethink Their Municipal Bond Portfolios
Anyone buying the Miami Beach 3.25% bonds of 49 is taking massive uncompensated risk.
Generally speaking, most entrepreneurs should have a barbell approach to managing their total wealth. This requires looking at the entire balance sheet when managing their assets, which I have discussed at length here.
Total Wealth Approach
In short, a Total Wealth approach considers the business assets and liabilities, as well as personal real estate and expected cash flows, side by side with financial assets.
Asa heuristic, entrepreneurs can think of their business interest as a concentrated equity position. This concentrated equity position typically overwhelms their financial assets in size. Because of this, the liquid financial assets should be treated as a completion portfolio and allocated last. This way, they can be used to balance out the business assets.
Inmost scenarios, the financial assets will need to be conservatively invested in order to complement the concentrated equity in the business. For many entrepreneurs, this means owning a lot of fixed income in general, and municipal bonds in particular.
Environmental Risks Unbalance the Barbell
As I've been writing about for years in blog posts and my book “An Ill Wind Blows Through Municipal Finance”, environmental risks have made municipal bond investing a lot more risky than even 10 years ago.
Yesterday, a Bloomberg article by Danielle Moran noted the environmental risks disclosed in a new Miami Beach municipal bond offering.
The bond’s Preliminary Official Statement had this to say in the "InvestmentConsiderations" section:
Projected changes in weather and tidal patterns place coastal areas like the City at risk of substantial wind or flood damage over time, affecting private development and public infrastructure, including roads, utilities, emergency services, schools, and parks. As a result, global climate change increases the potential of considerable financial loss to the City, including, without limitation, substantial losses in tax revenues. In addition, many residents, businesses and governmental operations could be severely disabled for significant periods of time or displaced, and the City could be required to mitigate these effects at a potentially material cost.
The bonds are rated Aa2 by Moody's and AA+ by S&P and mature as far out as May1, 2049.
Anyone buying the Miami Beach 3.25% bonds of 49 is taking massive uncompensated risk. In thirty years, Miami Beach could be partially submerged and effectively out of business, or could be spending half its annual budget on fighting a rising sea and frequent hurricane damage (and not servicing its debt).
Rebalancing the Barbell
Advisors have traditionally recommended in-state bonds for their clients, due to the additional tax breaks. (Florida is one of the few states that doesn't have a state income tax.)
This is an unforced error, and easily avoidable.
Entrepreneurs need to diversify away from where their business is located and from where they live. They also need to diversify away from high-risk states such as those on the coasts and Gulf of Mexico. This requires a more nuanced approach to municipal bond portfolio management.
As I’ve written about here, at the very least, entrepreneurs should have nationally diversified municipal bond portfolios. Better still, they could be more selective about which states they invest in and/or only buy insured or escrowed to maturity munis.
 Danielle Moran; Bloomberg; Climate Change: The Next Great Risk to Munis Is Already Here; April 18, 2019. Available at: https://www.bloomberg.com/news/articles/2019-04-18/climate-change-the-already-present-next-great-risk-to-munis; Accessed April 19, 2019.
 City of Miami Beach, Florida; General Obligation and Refunding Bonds, Series 2019; Preliminary Official Statement; April 4, 2019; Accessed on Bloomberg.