Cumberland Advisors Market Commentary – Managing Hurricane Risk in a Bond Portfolio

Author: John R. Mousseau, CFA & Patricia Healy, CFA, Post Date: August 10, 2020
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The Northeast continues to clean up from Hurricane Isaias, which swept up the Atlantic coast to New York and parts of New England on Thursday.

Below is a slide from a presentation by our good friend Tom Doe, who heads up Municipal Market Advisors (http://www.mma-research.com). Tom’s firm does in-depth quantitative and qualitative research on the muni market, and we show the slide with their permission.

As you can see from the slide, hurricane season is upon us, and some observers think it could be the busiest storm season since 1851. The hurricane risk forecast is very high this year (some say the highest ever), and water temperatures in the Atlantic and Gulf are setting records. Not only that, but as we have witnessed, storms are lingering longer, traveling farther, and dropping more rain, causing major flood damage in addition to wind damage. It is not just the coastal regions that are impacted, either, as we have seen the Midwest and inland South also sustain more damage in recent years. States, municipalities, and first responders have been proactive in preparing; and now we have the added complications of the coronavirus pandemic and how to manage evacuations and sheltering while still maintaining social distancing and other safe practices.

At Cumberland we track hurricane cones of uncertainty five days before landfall to determine if any of our municipal bond holdings could be negatively affected by the storm, and we act early to exit those holdings that are in the path of a storm. We did this ahead of Hurricane Katrina in August of 2005, exiting many of our Gulf Coast holdings, and we have employed this strategy for many subsequent storms. The key is not to be precise meteorologists but to do smart risk assessment. In the case of Katrina this meant selling selected credits stretching along the Gulf of Mexico from Galveston, Texas, across the Louisiana, Mississippi, and Alabama shorelines, all the way to the Florida Panhandle.

The selection of credits to sell involves looking at exposure (read, close to the coast) and size (Galveston general-obligation bonds: sell; Harris County (Houston) toll roads: keep). The idea is that by being proactive, credits with potential exposure can be sold, and bonds with similar ratings in different geographic areas can be bought, thus not disturbing duration, yield, and maturity considerations in a portfolio but reducing event-specific risk. In the case of Katrina, none of the credits we sold were terribly affected, with the one major exception of New Orleans bonds (water, airport, etc.). Today these credits continue to be backed by vibrant municipal entities, but at the time the HEADLINE RISK post-Katrina rendered many of the bonds illiquid. Did they come back? Yes, but it took a while.

What have we learned since Katrina?

In 2005, we didn’t have the interactive maps and online meteorological tools we have now. We did it the old-fashioned way, with a list of credits, push pins, and a Rand McNally map of the Gulf. Katrina was the biggest hurricane to hit the US in a century. As a practice, if two bonds from a state were similar in yield, credit, maturity, etc., we opted for the bond away from the coast. All other things being equal, we would rather own the bond of Columbia, SC, that is backed by the University of South Carolina than a limited-tax general-obligation pledge from Beaufort, SC, which is right on the coast.

There’s no magic number, but 100 miles from a coast is a good place to draw the line. And the essentiality of a service also factors into judgments. A water or sewer bond covers the type of service that will have priority getting back online (thus earning debt service).

Fifteen years after Katrina, we feel we are in a much better position to manage through strong hurricanes because of our bond selection method. Does that mean we avoid coastal credits totally? No. Yield on a bond is still important; but, in our view, if we are to assume that larger geographical/meteorological risk, we need to get paid for it.

And as we enter the heart of hurricane season, we continue to be vigilant on credits from the Gulf to the Carolinas, and from the Middle Atlantic to New England. And for all the benefits that Google Maps brings to our work, we still have multiple copies of the Rand McNally atlas, for that day when a Cat 4 barrels down on us.

Stay safe and enjoy the rest of the summer.

John R. Mousseau, CFA
President, Chief Executive Officer & Director of Fixed Income
Email | Bio

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
Email | Bio

With contributions by Amy Raymond
Fixed Income Dept. Manager


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