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Investors Pile Into Muni Bond ETFs

ETFtrends.com

Even with the specter of higher interest rates looming, some investors are not shying away from municipal bond exchange traded funds.

To this point, 2015 has been a banner year for inflows to fixed income ETFs and data indicate muni ETFs are getting in on that action. Investors “have added about $1 billion to ETFs that purchase state and local bonds, the fastest annual start since the funds started in 2007,” reports Michelle Kaske for Bloomberg.

The $4.4 billion iShares National AMT-Free Muni Bond ETF (MUB) h as garnered a significant chunk of that $1 billion, added almost $388 million in new assets this year. However, investors have not shied away from more speculative muni ETFs.

For example, the SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB) and the Market Vectors High Yield Municipal Index ETF (HYD) have added over $126 million combined this year. That after HYD and HYMB added $576 million and $156.7 million, respectively in new assets last year. [Investors Keep Flocking to Muni ETFs]

HYMB’s 30-day SEC yield is 4.09% while HYD’s is 4.4%. HYMB’s modified adjusted duration is almost nine years. The $1.5 billion HYD has a modified duration of 9.42 years, according to Market Vectors data.

Supply is set to pick up in 2015 as municipal bond sales rise and the amount of redemptions and maturing debt dip. States and local governments are expected to sell $8.6 billion in bonds over the next 30 days, compared to $6.4 billion planned sales for the coming month a week ago. Meanwhile, municipalities have stated that there will be $12.1 billion in redemptions. [Muni ETFs Face Supply Risk]

Muni debt is close to their cheapest since December 2013 relative to Treasuries. Looking at the rates on state and local bonds relative to federal debt, the ratio of interest rates hit 106 percent Thursday, which suggest that municipal bonds have weakened relative to the federal debt. Historically, the muni-to-Treasuries ratio has been below 100% since interest on state and local debt is tax-exempt, which make the assets more attractive for high-income investors.

Improving local and state government finances are bolstering inflows to muni ETFs.

“With local-government finances improving five years after the recession and the top federal income-tax rates the highest since 2000, investors are increasingly turning to ETFs as a way into the tax-exempt market,” according to Bloomberg.

Investors have also nibbled at rate-sensitive Build America Bond ETFs. Build America debt obligations were first created under President Barack Obama’s 2009 American Recovery and Reinvestment Act where municipalities sold $188 billion of the debt before the program expired at the end of 2010. The Build American Bonds helped diminish borrowing costs for state and local governments as part of a stimulus package. Local governments used the bonds to pay for infrastructure projects and received a 35% federal subsidy on interest payments.

The PowerShares Build America Bond Portfolio (BAB) and the SPDR Nuveen Barclays Build America Bond ETF (BABS) , with durations of 9.29 years and 12.68 years, respectively, have added over $110 million in new assets on a combined basis this year.

Market Vectors High Yield Municipal Index ETF

hyd

Tom Lydon’s clients own shares of HYD.