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Adding Some Yield To The Muni Trade

ETF Professor

Income investors embrace municipal bonds as a way of generating income and earning some tax advantages. Yet the S&P National AMT-Free Municipal Bond Index has an average yield of just over 2 percent and a 30-day SEC yield of 1.72 percent, indicating that municipal bonds can leave income investors wanting more yield.

As is the case with other corners of the bond market, there are high-yield opportunities avail­able with municipal bonds. Just see the recent new issue from Chicago and the declining credit quality of Puerto Rico municipals. The First Trust Municipal High Income ETF (NASDAQ: FMHI) is a new ETF providing access to junk-rated municipal bonds.

FMHI's primary objective is to deliver tax-exempt income with the potential for capital appreciation. The new ETF is actively managed.

A Rigorous Approach

While active management has taken its lumps in the equity space, some investors like the idea of this management style in the bond universe, particularly when it comes non-investment grade fare.

“The fund is managed by First Trust using a disciplined approach that focuses on a combination of quantitative analysis and fundamental research,” according to First Trust. “In seeking attractive income, the fund will focus on non-rated bonds, lower investment-grade bonds and below investment-grade or 'high yield' municipal bonds, while offering daily liquidity and full transparency of holdings.”

FMHI's management team is currently focusing on bonds with maturities ranging from five to 18 years, which it believes can provide some buffer against rising Treasury yields.

Advantages And Challenges

Improving fiscal health, thanks to higher taxes in some states, has bolstered the credit profiles of some municipalities, in turn driving yields lower on some muni debt.

Some municipalities face revenue issues and the specter of declining credit quality. Those concerns could highlight the advantages of FMHI's active management.

“Some municipalities have faced increasing economic challenges, which we believe has raised the importance of active credit analysis and municipal bond expertise,” said First Trust. “Unlike index-based ETFs that may simply rely on rating agencies for credit analysis, we believe it is critical to understand an issuer’s ability to meet its financial obligations. Active portfolio management allows the fund managers to make portfolio adjustments as conditions change.”

FMHI charges 0.55 percent per year, or $55 on a $10,000 investment.

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