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Manage Volatility, Generate Income with Muni Bond ETFs

Municipal bond exchange traded funds may not be the most exciting investment, but they have been maintained their momentum in 2016, providing investors with steady and stable returns.

Fixed-income investors should take a second look at municipal bonds as they begin to fall behind Treasury bonds.

“While tax-exempt munis have lagged strong-performing Treasuries so far in 2016, that relative weakness could offer investors a compelling entry point — an opportunity to buy in at a lower valuation and capture the potential income advantage that the tax-exempt asset class has to offer,” according to Peter Hayes, Head of BlackRock Municipal Bonds Group.

Related: Low Yields Haven’t Deterred Muni Bond ETF Investors

Specifically, Hayes points to three factors that have fallen under the radar but still support the muni outlook, including attractive yields, high quality and diversification.

For starters, munis offer yield generation and provide investors an attractive level of income relative to other fixed-income assets in what will likely be a prolonged low-yield environment.

The municipal market also comes with high quality and low volatility traits. The asset category has experienced lower volatility than other bond categories and tends to be less affected by Federal Reserve rate uncertainty than high-quality taxable investments, like Treasuries. Moreover, credit risk remains low among the munis group, with 10-year cumulative default rates at 0.24% for municipal bonds, compared to 11.16% for corporates.

Lastly, munis provide portfolio diversification and hedge against equity risk. Bonds are showing diverging correlations to equity risk. Moreover, the asset may offer a hedge against other risks that could affect investment portfolios this year, including ongoing China economic concerns and volatile oil prices.

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“While the recent equity market volatility and related investor flight to quality has benefited Treasuries most, we believe that has created an opportunity in municipal bonds,” Hayes added. “Any further underperformance relative to Treasuries, along with potential weakness around tax time, would present an attractive entry point into the tax-exempt asset class.”

ETF investors interested in the munis market have a number of options available. For investment-grade muni exposure, the iShares National AMT-Free Muni Bond ETF (MUB) has a 4.69 year duration and a 1.32% 30-day SEC yield, SPDR Nuveen Barclays Municipal Bond ETF (TFI) has a 6.78 year duration and a 1.54% 30-day SEC yield, VanEck Vectors Intermediate Municipal Index ETF (ITM) has a 6.59 year duration and a 1.61% 30-day SEC yield.

Related: 33 Muni Bond ETFs to Augment Income Generation

Additionally, muni investors can also squeeze out greater returns through high-yield options, like the VanEck Vectors High Yield Municipal Index ETF (HYD) and SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB) . HYD has a 3.98% 30-day SEC yield and a 8.62 year duration. HYMB has a 3.73% 30-day SEC yield and a 7.36 year duration.

For more information on the munis market, visit our municipal bonds category.