Municipal bonds and related exchange traded funds have been used as a relatively stable fixed-income stream. Nevertheless, investors should also be aware of the risks associated with the investment category.
For starters, one should know how a state, county or other local government can meet its financial obligations, writes Manisha Thakor, director of Wealth Strategies for Women at Buckingham and The BAM Alliance, for CNBC.
Specifically, muni debt issuers will issue either revenue bonds or general obligations.
Revenue bonds cover either essential purpose or non-essential services and are backed by a specific revenue stream. The essential purpose revenue bonds are backed by projects with very steady and predictable income streams, like water and sewer utilities. Non-essential service revenue bonds include projects with less predictable income streams, like new golf courses or hospitals.
The Deutsche X-Trackers Municipal Infrastructure Revenue Bond Fund (RVNU) is the only muni ETF to specifically target municipal revenue bonds, focusing solely on bonds that fund, state and local infrastructure projects such as water and sewer systems, public power systems, toll roads, bridges, tunnels, and many other public use projects where the interest and principal repayments are generated from dedicated revenue sources. [The Right Municipal Bond ETF Right Now]
General obligation bonds, on the other hand, are backed by a municipality’s taxing power, or typically from property taxes, for debt service payments. Consequently, the local government may hike taxes to meet debt payments.
Muni bond investors should also monitor the credit worthiness of their state issuers. ETF investors can also target some state-specific muni issuers.
For California exposure, the iShares California AMT-Free Muni Bond ETF (CMF) , SPDR Nuveen Barclays California Municipal Bond ETF (CXA) and PowerShares Insured California Municipal Bond Portfolio (PWZ) all largely come with heavy investment-grade AA-rated debt exposure, followed by AAA-rated and A-rated qualities.
Additionally, New York municipal bond ETFs, including the iShares New York AMT-Free Muni Bond ETF (NYF) , PowerShares New York AMT-Free Municipal Bond Portfolio (PZT) and SPDR Nuveen Barclays NY Muni Bond (INY) , also have a similar investment-grade quality tilt.
ETF investors may also choose from diversified investment-grade muni options, including the iShares National AMT-Free Muni Bond ETF (MUB) and the Market Vectors Intermediate Municipal Index ETF (ITM) , which weight state exposure by market-capitalization, so the states with the largest outstanding debt have the largest weight.
“Smaller municipalities may find it more difficult than larger ones to make up revenue short-falls,” Thakor said.
For more information on the munis market, visit our municipal bonds category.
Tom Lydon’s clients own shares of RVNU.