As investors adapt their fixed-income portfolios for the possibility of rising interest rates, select municipal bond exchange traded funds are worth evaluating.
The huge sell-off in municipal debt last year has created a great opportunity in the munis market, writes Andrew B.J. Chorlton, a portfolio manager at Schroder Investment Management, for InvestmentNews.
“The municipal bond investor base is composed of mostly domestic retail investors — U.S. taxpayers,” Chorlton said in the article. “When retail investors sold off their muni bond holdings they created a vacuum that has made municipal bonds much more compelling from a valuation standpoint than comparable long-term credit instruments such as U.S. Treasuries.”
Specifically, Chorlton points to the municipal bond ratio to Treasuries in 30-year maturities, which stood at 102%. The ratio now looks attractive compared to the 91% long-term average.
Municipal bonds also show supportive fundamental technical indicators. States and local municipalities have seen their fiscal health improve for the last 17 consecutive quarters, with the exception of some standouts like Detroit and Puerto Rico. Supply is also declining, with new issuance at a negative for the last six years. [Municipal Bond ETF Rally Still Has Legs]
Moreover, muni debt default rates are still historically low. The overall muni bond default rate was 0.107% in 2013, down from 0.144% in 2012. In comparison, U.S. junk bond default rates were 2.1% for 2013.
“Municipal bonds, whether purchased individually or as part of an investment in a mutual fund, also provide investors with additional diversification during a still-uncertain market,”Chorlton said in the article. “Investors who allocate assets to municipal bonds from corporate bonds may mitigate credit risk because municipal bond defaults have historically been very low (municipalities have the power to simultaneously cut services and raise taxes to shore up their coffers, which helps decrease the likelihood of defaults).”
Investors can take a look at a broad muni bond ETF, like the iShares National AMT-Free Muni Bond ETF (MUB) , which has a 6.24 year effective duration, has a 2.05% 30-day SEC yield and a 3.62% tax equivalent 30-day SEC yield for those in the highest income bracket. [Investors Flocking to High Yield Muni ETFs]
Those who are more concerned about rate risk can go down the yield curve. For instance, the iShares Short-Term National AMT-Free Muni Bond ETF (SUB) and SPDR Nuveen Barclays Short Term Municipal Bond ETF (SHM) come with shorter durations at 1.94 years and 2.85 years, respectively. SUB has a 0.28% 30-day SEC yield or a 0.49% tax equivalent 30-day SEC yield, and SHM has a 0.57% 30-day SEC yield or a 1.01% tax equivalent 30-day SEC yield. [Muni Nation: Second-Quarter Muni Outlook]
For more information on the munis market, visit our municipal bonds category.