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What Lies Ahead for Muni Bond ETFs in the Trump Era?

Zacks Equity Research

U.S. municipal bonds were enjoying a great rally this year until the surprise win of Donald Trump in the presidential elections put a break on it. Most of the muni bonds including the most popular iShares National Muni Bond ETF MUB are down in the range of 3% to 4%. This compares unfavorably with the broader stock market ETF SPDR S&P 500 ETF SPY, which is up more than 5% since November 8 (read: Will Muni Bond ETFs Bleed Under Trump or be Contrarian Bets?).  

The allure of municipal bonds generally lies in the fact that they make an excellent choice for investors seeking a steady stream of tax free income. Usually, the interest income from munis is exempt from federal tax and may also not be taxable per state laws, making them especially attractive for investors in the high tax bracket, looking to reduce their tax liability.

However, with the President-elect planning to slash the individual income-tax rates, the $3.7 trillion municipal market is bound to suffer as investors’ incentive from these tax-exempt bonds fall.

Meanwhile, the attractiveness of muni bonds also depends on the interest rates. While, a low rate environment acted as a tailwind in the earlier part of 2016, the future of these muni bond is bleak with Fed chair Janet Yellen warning that monetary tightening could be more aggressive than expected next year. Earlier this month, the Fed raised the benchmark interest rates by a modest 25 bps to 0.50–0.75% citing the U.S. economy’s growth momentum and an upbeat labor market. The Fed forecasts three rate hikes in 2017, up from two guided in September but kept the projection of three hikes each in 2018 and 2019 unchanged (read: Sole Fed Hike of 2016 Put These ETFs in Focus).

Silver lining

However, all is not lost for these bonds. Trump has proposed to introduce a burst of stimulus by increasing infrastructure spending package, easing regulations and tax cuts with the aim of accelerating economic growth and creating more jobs in the country. If his math is correct, then it could mean higher tax receipts and improved municipal finances. (read: ETFs & Stocks That Topped or Flopped After Trump Won).

Munis are comparatively more stable than equity or high yield bonds, making them the preferred choice in an economic climate marked by high levels of volatility. Several factors such as global growth slowdown and geo-political issues can flare up volatility.

So let’s take a look at couple of the most popular muni ETFs, any of which could be interesting picks for the long run. These products have a decent Zacks ETF Rank of 3 or ‘Hold’ rating (see: all the Municipal Bonds ETFs here):

iShares National Muni Bond ETF

The fund tracks the S&P National AMT-Free Municipal Bond Index and holds a large basket of 3,186 municipal bonds across a number of states and sectors. California munis take the top spot with nearly 23.1% of total assets, closely followed by New York at 19.7%.

The product focuses on mid- and long-term securities with average maturity of 5.66 years and effective duration of 6.25 years. MUB is one of the largest and most popular products in the national munis space with AUM of over $7.5 billion and solid average daily volume of more than 578,000 shares. The fund charges 25 bps in fees per year from investors.

PowerShares National AMT-Free Municipal Bond Portfolio PZA
 
This product tracks the BofA Merrill Lynch National Long-Term Core Plus Municipal Securities Index. It has amassed $1.3 billion in its asset base while charging 28 bps in annual fees. Volume is solid as it exchanges nearly 315,000 shares per day.

With 327 securities in its basket, the fund is heavily tilted toward mid-term securities with an effective duration of 7.92 years and modified duration of 5.40 years (read: Should You Buy These Bond ETFs Instead of Treasury?).

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SPDR-SP 500 TR (SPY): ETF Research Reports
 
PWRSH-NAT AMT (PZA): ETF Research Reports
 
ISHARS-NAMTF (MUB): ETF Research Reports
 
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Zacks Investment Research
 
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