DISCUSSION OF FUND PERFORMANCE (Unaudited)
For the period from October 1, 2019 through March 31, 2020, as provided by Daniel Rabasco and Jeffrey Burger, Primary Portfolio Managers
Market and Fund Performance Overview
For the six-month period ended March 31, 2020, BNY Mellon Municipal Income, Inc. produced a total return of -4.18% on a net-asset-value basis and -9.99% on a market price basis.1 Over the same period, the fund provided aggregate income dividends of $0.21 per share, which reflects a distribution rate of 5.11%.2
Municipal bonds declined during the reporting period, due largely to the market turmoil resulting from COVID-19 pandemic. The municipal bond market rallied through much of the period, supported by strong demand and interest rate cuts by the Federal Reserve (the “Fed”). But the emergence of the COVID-19 crisis resulted in a flight to safety that hurt municipal market performance.
The Fund’s Investment Approach
The fund seeks to maximize current income exempt from federal income tax to the extent consistent with the preservation of capital. Under normal market conditions, the fund invests at least 80% of the value of its net assets in municipal obligations and invests in municipal obligations which, at the time of purchase, are rated investment grade or the unrated equivalent as determined by BNY Mellon Investment Adviser, Inc. in the case of bonds, and rated in the two highest rating categories or the unrated equivalent as determined by BNY Mellon Investment Adviser, Inc. in the case of short-term obligations having, or deemed to have, maturities of less than one year.
To this end, we have constructed a portfolio based on identifying income opportunities through analysis of each bond’s structure, including paying close attention to each bond’s yield, maturity and early redemption features. Over time, many of the fund’s relatively higher-yielding bonds mature or are redeemed by their issuers, and we generally attempt to replace those bonds with investments consistent with the fund’s investment policies, albeit with yields that reflect the then-current interest-rate environment. When making new investments, we focus on identifying undervalued sectors and securities, and we minimize the use of interest-rate forecasting. We use fundamental analysis to estimate the relative value and attractiveness of various sectors and securities and to exploit pricing inefficiencies in the municipal bond market.
COVID-19 Concerns and Supply-Demand Factors Drove Municipal Bonds
Through most of the reporting period, the municipal bond market experienced strong demand against a backdrop of moderating economic growth and mundane inflation prospects. Demand was driven especially by investors in states with high income-tax rates. Many of these investors moved into municipal bonds as a way to reduce their federal income taxes, which rose as a result of the cap on the federal deductibility of state and local taxes in the Tax Cuts and Jobs Act of 2017.
Actions by the Fed early in the period, including two rate cuts, also helped performance in the municipal bond market. This contributed to a decline in yields across the municipal bond
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DISCUSSION OF FUND PERFORMANCE (Unaudited) (continued)
yield curve, though investors largely favored longer-term issues, causing the municipal bond yield curve to flatten.
Supply increased somewhat during the reporting period, as low interest rates led issuers to seek to capture favorable financing. New issuance may have been inhibited by the absence of advance refunding, which was eliminated by the Tax Cuts and Jobs Act of 2017.
The municipal bond market continued to perform well early in 2020 until the emergence of the COVID-19 crisis, which resulted in turmoil and hindered returns, particularly in March. A conflict between Russia and Saudi Arabia over oil prices also contributed to economic deterioration and uncertainty, leading to a flight to quality.
Actions by the Fed, including two emergency rate cuts in March 2020, provided some support to the municipal bond market, but technical supply and demand factors became the predominant driver. Though the municipal bond market often benefits from economic uncertainty, in this environment that was not the case. Fears of widespread economic damage due to the COVID-19 caused investors to shift out of the municipal bond market, resulting in large outflows from municipal bond mutual funds. In a normal market, broker-dealers would step in to buy municipal bonds. But a decline in the municipal bond market, combined with a rally in the Treasury market, prevented them from hedging their municipal bond purchases by shorting Treasuries, as they normally do.
In addition, the municipal bond market was hurt by the inability of large investors to capitalize on the volatility. As municipal bond yields rose, insurance companies and other large investors were expected to step in, but since there was also a lack of liquidity in corporate bonds, which normally would have financed their municipal bond purchases, these investors were hindered in their ability to act. As a result, the municipal market yield spreads rose significantly, especially among high yield and lower-rated investment grade bonds, weakening performance.
Fundamentals in the municipal bond market were quite healthy heading into the crises exhibiting strong fiscal balances and “rainy day” funds.
Asset Allocation and Leverage Hampered Fund Results
The fund’s performance was hindered during the reporting period by its overweight position in revenue bonds and an underweight position in general obligation bonds. Security selection was unfavorable as well, as positions in Illinois and Chicago general obligation bonds underperformed. In addition, positions in the health care, airport and tobacco sectors were detrimental. The fund’s tender option bond positions, also hindered performance as the funding costs associated with this leverage skyrocketed. Additionally, the fund hedged the added duration of the tender option bonds by shorting long-term Treasuries; however, this hedge against rising interest rates became untenable as rates on long-term Treasury securities actually declined.
On a more positive note, the fund’s performance was assisted by its yield curve positioning. Two-year and five-year bonds, in particular, performed well, and the fund’s longer duration proved advantageous for the earlier portion of the period.
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A Constructive Investment Posture
Despite the recent turmoil and the continuing economic uncertainty, we remain, on a whole, constructive on the medium to long term prospects of the market. Although defaults and credit downgrades are likely, the economy will be supported by the COVID-19 Aid, Relief, and Economic Security (CARES) Act, and programs recently announced by the Fed, including direct lending to municipalities, should support the municipal bond market. The fund increased its income generation prospects by executing bond swaps out of lower book yielding issues into those offering higher yields as a result of the market dislocation characterized by spread widening.
April 15, 2020
1 Total return includes reinvestment of dividends and any capital gains paid, based upon net asset value per share or market price per share, as applicable. Past performance is no guarantee of future results. Market price per share, net asset value per share and investment return fluctuate. Income may be subject to state and local taxes, and some income may be subject to the federal alternative minimum tax (AMT) for certain investors. Capital gains, if any, are fully taxable.
2 Distribution rate per share is based upon dividends per share paid from net investment income during the period, divided by the market price per share at the end of the period, adjusted for any capital gain distributions.
Bonds are subject generally to interest-rate, credit, liquidity and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes, and rate increases can cause price declines. High yield bonds are subject to increased credit risk and are considered speculative in terms of the issuer’s perceived ability to continue making interest payments on a timely basis and to repay principal upon maturity. The use of leverage may magnify the fund’s gains or losses. For derivatives with a leveraging component, adverse changes in the value or level of the underlying asset can result in a loss that is much greater than the original investment in the derivative.
Recent market risks include pandemic risks related to COVID-19. The effects of COVID-19 have contributed to increased volatility in global markets and will likely affect certain countries, companies, industries and market sectors more dramatically than others. To the extent the fund may overweight its investments in certain countries, companies, industries or market sectors, such positions will increase the fund’s exposure to risk of loss from adverse developments affecting those countries, companies, industries or sectors.
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