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Muni ETFs Look Cheap After Puerto Rico Induced Sell Off

Municipal bonds, along with related exchange traded funds, are trading at their deepest discount to U.S. Treasuries in four months after another round of debt concerns over Puerto Rico’s finances sparked a sell-off in muni funds.

High-yield muni ETFs suffered the brunt of the blow, with the Market Vectors High Yield Municipal Index ETF (HYD) down 2.4% and SPDR Nuveen S&P High Yield Municipal Bond ETF (HYMB) 1.1% lower over the past month.

Meanwhile, investment-grade muni ETFs iShares National AMT-Free Muni Bond ETF (MUB) and SPDR Nuveen Barclays Municipal Bond ETF (TFI) were up 0.5% and 0.3% over the past month, respectively.

Benchmark 10-year muni yields were hovering around 2.44% while 10-year Treasuries were at around 2.51%, making the ratio between the two yields about 97%, the highest since March 13, which also indicated that local debt has cheapened on a relative basis, reports Brian Chappatta for Bloomberg.

“As munis begin to cheapen up and Treasuries stay stable or rally, at some point people are going to say munis are a good relative value,” Dan Toboja, senior vice president of Ziegler Capital Markets, said in the article.

Toboja also believes that investors may return to the relatively higher tax-free yields in munis as supply next week is set to come in at about $4.7 billion, compared to the 2014 average of $5.4 billion. [Low Supply to Support Municipal Bonds Market, ETFs]

In the week through July 9, investors pulled $790 million from muni funds, with the majority of assets coming out of long-term and high-yield debt, after Moody’s Investors Service cut Puerto Rico’s rating to B2, or five levels below investment-grade, on July 1 due to a new law allowing some companies to restructure their debt. Puerto Rico has issued $73 billion in debt, or about 2% of the munis market.

Some hedge funds and investors are seeing an opportunity after the sell-off. Eli Combs, president of MeehanCombs LP, argues that Puerto Rico bonds will rebound once the initial shock wears off.

“There’s fear that’s been injected by this change in the law,” Combs said in a separate Bloomberg article. “The reality, from our perspective as distressed-debt investors, is that the market tends to panic and then it tends to forget.”

The high-yield muni ETFs include a small allocation to Puerto Rican debt. HYD has a 4.3% in Puerto Rico and HYMB includes a 5.4% position in the commonwealth. HYD has a 10.5 year duration and a 5.13% 30-day SEC yield, or 8.5% taxable equivalent 30-day SEC yield. HYMB has a 9.17 year duration and a 4.66% 30-day SEC yield, or a 8.22% taxable equivalent yield.

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

Max Chen contributed to this article. Tom Lydon’s clients own shares of HYD.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.