The Lowdown on Deutsche's New Bond Fund

Roger Nusbaum
June 5, 2013

NEW YORK ( TheStreet) - Deutsche Bank has quietly built a line of unique exchange-traded funds. This week, it expanded its lineup with the db X-trackers Municipal Infrastructure Revenue Bond Fund .

The municipal bond market typically divides into two categories: general obligation bonds, which are back by the credit and taxing power of the state, and revenue bonds, which are tied to an income stream like tolls collected on a bridge or highway.

Before the financial crisis, it was generally accepted that general obligation, or GO, bonds were safer than revenue bonds, but with so many states facing financial problems, investors gravitated to revenue bonds because the revenue in question must go toward interest payments as stipulated in the bonds' covenants.

With that in mind, RVNU owns only revenue bonds, more specifically revenue tied to things like water, toll roads and other infrastructure projects. That might seem like a Build America Bond fund. But those bonds, which were created as part of the American Recovery and Reinvestment Act of 2009, are taxable, and the bonds held in RVNU are tax exempt. There are a couple of Build America Bond funds including the PowerShares Build America Bond Portfolio .

Bonds tied to transportation make up the largest sector of the new Deutsche fund at 42%, followed by water and sewer at 24%, with the other sectors being much smaller. The larger states in the fund are New York 23%, Texas 20%, Florida 13% and California 11%. The credit quality is good but not AAA; about 80% of the fund is AA or A rated.

Deutsche Bank reports that the "yield to worst" for the underlying index is 3.22%, which after accounting for the 0.30 expense ratio, could put the yield of the fund just under 3%. As is the case with all ETFs, however, future payouts should be expected to vary. The use of the word "worst" as in yield to worst refers to least favorable outcome possible in terms of any of the fund's holdings being called before maturity.

Where the fund might pose a problem for investors is with the maturity. The average final maturity is 24 years with 21% of the fund maturing in 10-20 years, 62% maturing in 20-30 years and 15% going out past 30 years.

The threat here is that with interest rates close to all-time lows there is only one direction they can go, which is higher. In the last few weeks, rates have moved up a little, and bond ETFs have dropped enough to matter. For example, in the last month the iShares Barclays 20+ Year Treasury Bond ETF has dropped by almost 6%, which equates to more than two years of dividends for that fund based on the current yield.

RVNU's duration, however, is much shorter, less than 10 years. That means that the fund should be less sensitive to rising rates initially but that as rates go up, duration, or sensitivity to rising rates, will also increase because a bond with a 3% coupon is very unlikely to be called if the prevailing interest rate is 5%.

The fund should help allay any lingering concerns about states' leftover from the financial crisis, but there will likely be a better entry point after rates start to move up.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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