Franklin Muni Fund Beat Index on Credit Picks, Not Curve Bet

Franklin Resources’ New York intermediate-term tax-free muni fund outperformed its benchmark in the first quarter, the asset manager said in a commentary. An overweight to bonds maturing in 10 years or more hurt relative returns during a period when the yield curve stayed flat. An overweight to bonds without an external credit rating, along with BBB-rated bonds, more than offset that drag. That mix worked.

The fund’s experience reflects a quarter where new issue supply ran above the average of recent years, according to Barclays data cited by Franklin Templeton. The war in the Middle East, which began in late February, continued through the quarter, the commentary noted. The fund still ended ahead of the Linked Bloomberg New York Muni Bond/10-Year Muni Bond Index.

For investors in municipal bonds, the quarter underlined the cost of duration extension when the curve does not steepen. Funds that loaded up on longer-dated paper to capture extra yield got punished. Spreads did not widen enough to compensate. On the credit side, overweight positions in lower-rated debt paid off as demand for yield pushed investors down the quality spectrum. Bonds with no external rating – typically those that rely on the issuer’s own credit quality – benefited from that hunt for carry.

The readthrough for the broader muni sector has two sides. New issuance has been heavy, which could pressure secondary market prices if demand does not keep pace. The Middle East conflict has not yet caused a broad risk-off shift into Treasuries, the fund’s performance data suggest. Fund managers who leaned into credit selection rather than duration likely did better than those who tried to time the curve.

For asset managers, Franklin Resources (BEN) in particular, the fund’s performance is a positive data point. The firm manages over $1.4 trillion in assets across fixed income and equities, with additional exposure to alternatives and multi-asset solutions. Franklin Templeton’s specialist investment managers have a broad muni platform. A fund that beats its benchmark on credit skill reinforces the firm’s fixed-income franchise, even if the duration call was wrong.

Barclays (BCS), which provided the issuance data, has a large muni underwriting business. The volume also depends on issuer demand for financing, which may slow if borrowing costs stay elevated.

In the quarter, credit overweights contributed more to relative returns than curve overweights, the fund’s performance breakdown showed. Duration bets become a secondary factor when the curve is flat. The funds that recognized that – like Franklin Templeton’s New York intermediate-term offering – found a way to outperform even with a headwind from their curve position.

Franklin Templeton manages over $1.4 trillion in assets, the company said.