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The Case for Muni Bond ETFs in Second Half of 2019

This article was originally published on ETFTrends.com.

Fixed income has seen a number of record flows this year into exchange-traded funds (ETFs) as investors look to gain core bond exposure as a more dovish central bank looks to cute interest rates this year. One area where investors may want to consider for additional fixed income exposure is the municipal bond market, which could see additional strength in the second half of 2019.

"Looking at municipal supply thus far in 2019, issuance has been on target relative to expectations," wrote New York Life Investments’ MacKay Municipal Managers. "Through June 27, 2019, year to date 2019 issuance is $168 billion with net supply of -$9 billion. We believe austerity measures at the state and local levels have led to more modest issuance thus far in 2019."

"At the same time, we believe supply will increase in the second half of 2019 as issuers increase funding for capital investment, particularly in the 20 states led by new governors motivated to make an early impact on their state," they added.

New York Life Investments in partnership with IndexIQ actively manage two Muni Bond ETFs:  IQ   MacKay Shields Municipal Intermediate ETF (NYSE Arca: MMIT)  and the  IQ MacKay Shields Municipal Insured ETF (NYSE Arca: MMIN) .

MMIT seeks current income exempt from federal income tax. The Fund seeks to achieve its objective by investing primarily in investment grade municipal bonds and will also seek to enhance total return potential through the subadvisor’s active management approach. MMIN seeks current income exempt from federal income tax.

MMIN principally invests in investment-grade municipal bonds covered by an insurance policy guaranteeing the payment of principal and interest, and will also seek to enhance total return potential through the subadvisor’s active management approach.

Municipal bonds are a specific corner of the bond market that has its own nuances to be wary of, such as costs and tracking errors.

Another pair of ETF plays are the Vanguard Tax-Exempt Bond ETF (VTEB) and iShares National Muni Bond ETF (MUB) .

With bond market mavens warning investors of headwinds in the fixed income space like the possibility of an inverted yield curve, rising rates and BBB debt sliding out of investment-grade, investors need to be keen on where to look for opportunities.

One area is within the municipal bond space, which may have gotten a boost following last November’s midterm elections. In particular, with respect to infrastructure spending—it’s one of the few things, if any, that Democrats and Republicans can agree on, but with the newly-divided Congress, this could fuel municipal bond ETFs.

Still, investors need to be aware of the costs associated with investing in this fixed income space, as well as certain tracking errors that could arise with respect to their prices. As such, it's appropriate to select the necessary ETFs that address these concerns like VTEB and MUB.

VTEB tracks the Standard & Poor's National AMT-Free Municipal Bond Index, which measures the performance of the investment-grade segment of the U.S. municipal bond market. MUB seeks to track the investment results of the S&P National AMT-Free Municipal Bond IndexTM, which also measures the performance of the investment-grade segment of the U.S. municipal bond market.

The sampling approach means that both funds hold a subset of bonds within the index in order to replicate the yield, duration, and credit quality of the debt. This method allows the funds to avoid trading expensive bonds that could harm performance and in addition, minimize tracking errors.

With respect to an average net expense ratio of 0.32 percent in their category, both funds deliver very low costs--0.08 percent for VTEB and 0.07 percent for MUB.

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