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First Trust Rolls Out Managed Municipal Bond ETF

Zacks Equity Research

Muni bond ETFs saw a bumpy 2013 thanks to investors’ inclination toward equity markets, the low-return nature of muni bonds, poor fiscal health in many municipalities and taper talks that spoiled the flavor of all sorts of long-duration bond investments.
 
However, things took a sharp turn this year. As nearly $3.7 trillion municipal market is riding high mainly on rising tax concerns, risk-off trade sentiment and improving credit quality of many municipal bond issuers.
 
Convinced by this trend, First Trust has rolled out an actively managed fund in this corner of the market. The new fund began trading on May 15, 2014 as First Trust Managed Municipal ETF under the symbol FMB (read: Deutsche Bank Launches Muni Bond, Utility ETFs).
 
The issuer also pointed out some interesting facts about the muni markets like risk-adjusted returns of tax-exempt municipal bonds that make these more attractive than major asset classes on a taxable equivalent yield basis.
 
In addition, returns of municipal bonds have historically had a low correlation to other asset classes. First Trust also revealed that muni bonds boasted low default rates compared to corporate bonds in each rating class in the past.
 
FMB in Focus

This fund looks to generate current income by investing in municipal bonds that have a Federal tax exempt status (read: Looking For Income? Try High Yield Muni ETFs). Long-term capital appreciation is its secondary purpose.
 
First Trust structured the fund in an active manner mainly to avoid the worst in the municipal market as some munis are still buckling under economic pressure.
 
Unlike the passive approach which mostly depends on rating agencies’ grades for its own credit analysis, First Trust looks to evaluate the issuer’s capability to meet its financial obligations. FMB invests 65% of its portfolio in investment grade municipal bonds. However, to deliver a high yield, the fund allocates 35% of the basket to junk bonds.

Currently, the fund holds 32 municipal bonds in its portfolio and is well spread among individual bonds. Nassau County NY Local Econ Assi 5% due July 1, 2024 (5.74%), Piedmont Sc Muni Power Agency Electric 5% due January 1, 2024 (4.22%) and Central Plains Energy Project 5% due September 1, 2024 (4.15%) are the top three holdings. The fund charges 65 basis points annually, which is quite high in the muni bond ETFs space.

How does it fit in a portfolio?
 
Muni bonds have been the name of the game this year thanks mainly to the recent tax hikes which have spurred the demand for tax-exempt investment options. Muni bonds pay interest that is free from federal income tax, making these excellent choices for those who are in a high tax bracket and are looking to reduce their tax liabilities. Also, muni bonds are known as relatively safer options than corporate bonds.
 
Additionally, after a beaten-down 2013, investors seek to play the unvalued yet promising fixed-income corner of the market. As we all know, interest rates are hovering at extremely low levels this year giving an outright edge to bonds over equities.
 
Furthermore, the Fed’s vow to keep interest rates near zero levels as long as the economy needs assistance acted as a silver lining for the bond market. As a result, yields in the municipal market plunged to an 11- month low level in early May, per the Bloomberg data.
 
Even if the rates rise this year or in the next, volatility will likely be the most in the short end of the curve. Also, this fund could come in handy for investors looking to reduce interest rate risk in the municipal bond space. Its focus on the intermediate part of the curve makes the fund less vulnerable to interest rate risk unlike longer-dated bonds (See all Municipal Bond ETFs here).
 
ETF Competition
 
There are a number of muni bond ETF options currently trading in the market with iShares National AMT-Free Muni Bond ETF (MUB) leading the space in terms of AUM. However, duration wise, Market Vectors-Intermediate Municipal Index ETF (ITM) and Intermediate Municipal Bond Strategy Fund (MUNI) will give FMB a run for money as all the funds target the intermediate portion of the curve (read: Top Ranked Muni Bond ETF in Focus: BABS).
 
Given the stiff competition in the space, FMB needs to sell its active management strategy to stand out. If this technique holds up, this fund may become a preferred bet among investors seeking low risk bond exposure, though the battle seems to be a tough one especially when the fund costs relatively more for its unique strategy.
 
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